A Factor Analysis Approach of International Portfolio Diversification: Does it Pay Off?

AbstractOne of the most intriguing and debated issues in portfolio theory are the interrelationships between stock markets and the real effects of these to international portfolio diversification. As markets become more integrated the co-movements between markets tend to rise, undermining the benefits of international portfolio diversification. Our paper proposes to study the changes in the linkages between stock markets returns from 12 countries with a factor analysis approach between September 1997 and May, 2012, emphasizing the Eastern European markets. The Principal Component Analysis (PCA) and the Maximum Likelihood (ML) methods are used to study the patterns underlying the stock market relationships