Global Diversification with Local Stocks: A Road Less Traveled

Utilizing approximately 51,000 sample firms from developed markets over 1995-2014, we document a stark heterogeneity in global integration at the firm-level and study its implications for diversification. Specifically, the adjusted R-square, our integration measure, is widely distributed across firms, within and across sample markets. A firm’s integration is significantly affected by its style, country, and industry attributes. Systematically identifying and holding “local stocks” that are minimally driven by the common global factors, investors can significantly benefit from diversification within developed markets. Thus, the diversification gains solely inferred from the market indices much understate the potential benefits that world markets can provide.