Risk Exposures and International Diversification: Evidence from iShares


  • Maosen Zhong,

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  • Hui Yang

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       The authors are respectively from the UQ Business School, University of Queensland, Australia; and the Department of Finance, Kansas State University, USA. Part of the data used in this study was graciously provided by Werner Antweiler, Natalya Delcoure and Kenneth French. The authors gratefully acknowledge Natalya Delcoure, Peter Pope, Andrew Stark, Alex Taylor, Hua Zhang, and participants at the Chinese University of Hong Kong seminar, the University of Queensland seminar, the 2004 Eastern Finance Association (US) Conference and the 2004 JBFA Capital Markets Conference for their helpful comments. All errors remain the responsibility of the authors.

Maosen Zhong, UQ Business School, The University of Queensland, Brisbane, QLD 4072, Australia.
e-mail: m.zhong@business.uq.edu.au


Abstract:  We examine the newly developed international diversification instruments–iShares traded on the American Stock Exchange. Given the fact that iShares can be created and redeemed at will, the daily price of an iShare is expected to be equal to the daily portfolio value of the underlying assets in the home-country market. Therefore, theoretically, iShare pricing should be influenced by the risk from the iShare's home-country market and not the risk from the US market, per se. We evaluate the risk exposure of iShare prices to the US market (non-fundamental effect) as well as the home-country market (the fundamental effect). We find that most iShare returns are significantly influenced by and sensitive to the US market risk. Moreover, the US market appears to be the key permanent driving factor and the home-country market is a pronounced transitory driving force for iShare prices. These findings indicate the presence of limits of international arbitrage for iShares. As a result, the international diversification benefits of iShares become questionable.