A Note on International Portfolio Diversification with Short Selling

In this paper, the diversification benefits of using stock index futures are examined. Empirical evidence shows that traditional diversification in international equity markets does not produce a risk adjusted performance superior to the US market. An explanation for this result is that restrictions on short selling prohibit the best allocation of resources when overseas stock markets are riskier and have worse returns. However, when such restrictions are eased for short selling in index futures markets, investors are enabled to both allocate their investments more efficiently and to construct a superior portfolio.