International bond diversification: Mean variance intersection and spanning test: Danish perspective

Brynjolfur Einar Sigmarsson

Student thesis: Master thesis


This master thesis in Finance and Strategic Management at Copenhagen Business School, analyses if international bond diversification is beneficial for Danish investors holding a domestic government bond portfolio using mean variance intersection and spanning test. Furthermore, it examines if diversification benefits have changed in the last two years compared to last ten years. Modern portfolio theory suggests that investors should hold internationally diversified portfolios, because diversification is supposed to improve the reward to risk ratio of the overall portfolio. This improvement of the risk to reward ratio is mostly due to low correlation between countries. It is widely agreed that investors hold too little of their financial wealth in foreign securities. In the past, this could be explained by the general lack of international financial integration and national barriers to capital flows. However, the growth and increased integration of capital markets over the past 20 years has not led to dramatic portfolio reallocations. While recent years have witnessed an increase in international diversification, holdings of domestic assets are still far too high to be consistent with the standard theory of portfolio choice. The empirical study strives to answer the research questions put forward in the introduction chapter. The analysis looks at two periods, ten year period and two year period. This is done to see if diversification benefits decrease in the last two years of the study period compared to the whole ten year period. To conclude on that country economic fundamentals between countries are compared as well as comparison of yield curves for nine countries. To test is Danish investors benefit from international diversification, mean variance intersection and spanning test is used. The test is applied on the two periods mentioned, with both short sales allowed and restricted and where returns are hedged and unhedged. The main conclusion is that Danish investors generally experience diversification benefits by adding foreign bonds to their domestic bond portfolio. Further, financial integration is found to increase within the largest developed countries. Diversification benefits are most for the last two year of the study period when short sales are allowed, where it is believed that the financial crisis has not fully reach emerging markets and small economies like Denmark.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2009
Number of pages112