Foreign securities are generally considered to be more risky

Foreign securities are generally considered to be more risky than domestic securities. Given this assumption, explain how adding foreign securities into a domestic portfolio can affect the Markowitz efficient portfolios.

Solution

Diversification in portfolio theory means to reduce risk measured as a variance of expected asset returns at a given level of return by investing in additional international assets. Because the correlation is less than one when international securities are added to portfolio of domestic securities.

In this context that the opportunity set of possible investment alternatives is enlarged extensively. First, internationally s more assets are available, e.g. shares not only in the American Stock market but as well in the European stock markets and emerging markets. Secondly, many more kinds of products are available. Typically the Portfolio Theory is discussed in the context of stock markets. But on the other hand assets are other products like bonds, mutual funds, exchange traded funds, American Depository Receipts or Hedge Funds.