Country versus Region Effects in International Stock Returns

Robin Brooks and Marco Del Negro
Working Paper 2002-20b
Revised August 2004

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An empirical regularity in the portfolio diversification literature is the importance of country effects in explaining international return variation. We develop a new decomposition that disaggregates these country effects into region effects and within-region country effects. We find that half the return variation typically attributed to country effects is actually due to region effects, a result robust across developed and emerging markets, with the remaining variation explained by within-region country effects. For the average investor, this means that diversifying across countries within Europe, for example, delivers half the risk reduction possible from diversifying across regions globally.

JEL classification: G11, G15

Keywords: diversification, risk, international financial markets, industrial structure

An earlier version of this paper was circulated as “International Stock Returns and Market Integration: A Regional Perspective.” We are grateful to Geert Rouwenhorst for extensive comments and suggestions and to Eisuke Okada for excellent research assistance. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Robin Brooks, Research Department, International Monetary Fund, 700 19th Street N.W., Washington, D.C. 20431, 202-623-6236, 202-623-4740 (fax),, and Marco Del Negro, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, Atlanta, Georgia 30309, 404-498-8561, 404-498-8956 (fax),