Faculty Scholarship 1994 - Present

Co-Movements of the World's Sector Index Returns

In this paper, we study the portfolio diversification implications of the co-movements of ten national sector indexes in nineteen developed countries with the Principal Components Analysis (PCA) methodology. U.S. sector indexes are more closely correlated with one another than with foreign sector indexes. We find that U.S. investors can obtain greater portfolio diversification benefit by investing globally, even if the investments are in only one sector in different countries, as compared with investing in ten different sectors domestically within the U.S. The sector indexes of countries in the same geographical region are generally grouped together in the same principal component. Therefore, we conclude that geographical diversification can help global investors maximize diversification benefit within the same sector. Our findings show that the utilities (UTIL) sector has the largest number of principal components and the information-technology (ITECH) and cyclical-service (CYSER) sectors have the smallest number of principal components in both bull-market and bear-market periods (i.e., the UTIL sector provides the greatest diversification opportunities and the ITECH and CYSER sectors provide the least diversification opportunities within the same sector in both periods). The cross-correlation results indicate that U.S. sectors have negative correlation or very low positive correlation with many foreign sectors in other developed countries both in the bull market and in the bear market with excellent global diversification opportunities.