An Industrial Organization Approach to International Portfolio Diversification: Evidence from the U.S. Mutual Fund Families

Abstract

Although the lack of international portfolio diversification has long interested the financial economics literature, the role of financial intermediaries in the market for diversified portfolios has rarely been studied. In this paper, I introduce a microeconomic aspect of under-diversification by examining a new data on U.S.-based mutual fund families' global diversification. I document the fund families' investments in global equity markets and explore features of supply and demand in the mutual fund market to explain their limited global diversification. Demand estimation confirms that consumers are not only sensitive to the fund families' portfolio characteristics such as global diversification, but also to the non-portfolio characteristics such as fund family age and size. On the supply side, the model of fund families' global investment decisions uses a revealed preference approach and shows small cross-border investment frictions can justify the fund families' observed limited global diversification. Other factors such as destination country's investor protection level and fund family's investment experience significantly affect the degree of diversification as well. (JEL G11, G23, L21, F30)

A Demand System Approach to Asset Pricing

“…We have also assumed that the wealth distribution is exogenous, or more fundamentally, that net capital flows between institutions are exogenous. By modeling how households allocate wealth across institutions (e.g., Hortaçsu and Syverson 2004;Shin 2014), we could have a more realistic demand system to better understand the relative importance of substitution across institutions versus substitution across assets within an institution.…”