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Financial Globalization and Its Implications for Diversification of Portfolio Risk

Ramu Thiagarajan, Jiho Han, Aaron Hurd, Hanbin Im and Gaurav Mallik
The Journal of Investing October 2021, 30 (6) 22-33; DOI: https://doi.org/10.3905/joi.2021.1.197
Ramu Thiagarajan
is a senior investment advisor at State Street Global Advisors in Stamford, CT
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Jiho Han
is a senior quantitative researcher, FICC Research at State Street Global Advisors in Boston, MA
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Aaron Hurd
is a senior portfolio manager, currency at State Street Global Advisors in Boston, MA
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Hanbin Im
is a quantitative researcher at State Street Associates in Cambridge, MA
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Gaurav Mallik
is the chief portfolio strategist at State Street Global Advisors in Boston, MA
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Abstract

Trade disputes and the impact of the COVID-19 pandemic on global supply chains have drawn much attention to the notion of “deglobalization.” The common concern is that the steady trend of globalization and its many benefits may reverse. But the globalization trend is not a monolith. In this article, we show that although trade globalization has stalled since the Global Financial Crisis (GFC), financial globalization has continued to increase. We further show that financial globalization has a much more significant impact on portfolios than trade globalization. The primary mechanism of this impact, US dollar hegemony, impacts portfolios primarily through increased spillover of US monetary policy shocks. The two implications for investors are: (1) global equity markets have become increasingly correlated and are likely to stay that way, and (2) this increased correlation reduces the benefits of portfolio diversification and leads to a more concentrated exposure to US monetary policy shocks.

Key Findings

  • ▪ Financial globalization has increased steadily even as trade globalization has stalled over the past decade.

  • ▪ Increased financial globalization amplified by increased US Dollar hegemony raises the correlation of global equity markets, reduces efficacy of geographic diversification, and concentrates exposure to US monetary policy shocks.

  • ▪ Therefore, investors must step beyond the simple equity/fixed income paradigm to consider other opportunities to diversify equity risk such as commodities, currencies, alternatives, or low volatility strategies.

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The Journal of Investing: 30 (6)
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Financial Globalization and Its Implications for Diversification of Portfolio Risk
Ramu Thiagarajan, Jiho Han, Aaron Hurd, Hanbin Im, Gaurav Mallik
The Journal of Investing Sep 2021, 30 (6) 22-33; DOI: 10.3905/joi.2021.1.197

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Financial Globalization and Its Implications for Diversification of Portfolio Risk
Ramu Thiagarajan, Jiho Han, Aaron Hurd, Hanbin Im, Gaurav Mallik
The Journal of Investing Sep 2021, 30 (6) 22-33; DOI: 10.3905/joi.2021.1.197
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  • Article
    • Abstract
    • TRENDS IN GLOBALIZATION
    • IMPACT OF FINANCIAL GLOBALIZATION ON ASSET RETURNS
    • CONCLUSION
    • ACKNOWLEDGMENTS
    • APPENDIX A
    • ENDNOTES
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