Comment

Abstract

Dennis Quinn and Hans‐Joachim Voth’s paper “Free Flow, Limited Diversification: Openness and the Fall and Risk of Stock Market Correlations, 1890–2001” provides important new data and insights into the causes of the portfolio home bias puzzle, a topic that has intrigued economists for decades (see Lewis [1999] for a summary of the literature). Historically, the correlation of equity returns across countries has been relatively low, suggesting that investors could significantly reduce risk by diversifying their portfolios to include greater shares of foreign stocks. But, investors often have not done so. Rather, they have tended to overweight domestic equities relative to foreign equities. This paper provides evidence that the lack of international portfolio diversification in part reflects restrictions on capital mobility. In a nutshell, investors historically did not take advantage of the hypothesized gains from international diversification because they were not allowed to do so. In particular, the authors find that the low historical correlation in equity returns is associated with periods in which capital controls were very restrictive. With the widespread relaxation of capital controls in recent decades, the correlations of equity returns across countries have risen dramatically, suggesting that the hypothetical benefits from diversification have shrunk just as investors have gained the ability to take advantage of them. The paper makes two key contributions. First, the authors extend the Quinn‐Toyoda measure of capital account openness to cover over 110 years of data for 16 countries. Data are a public good essential for research, and the creation of new high‐quality data is worthy of high praise on its own. Second, the paper provides compelling evidence of a positive empirical link between theirmeasure of capitalmarket openness and correlations in equity returns across pairs of countries. Above and beyond the application to the portfolio home bias puzzle, these