What Explains the Benefits of International Portfolio Diversification?

This study uses a large sample of international stocks to examine the sources of the benefits of international portfolio diversification. It finds not only that international diversification outperformed industrial diversification over the past 25 years, but also that the gains from international diversification derive primarily from mitigating market and political risks. Economic risk appears important for investors giving more weight to smaller countries, while financial and inflation risks appear more important to funds limited to large countries. Risks related to the quality of the legal and credit environments seem less important for international diversification