International Diversification and Estimation Risk: Australian Evidence

This paper examines whether the benefits to the Australian investor from international diversification documented by previous Australian studies are still present when we control for estimation risk. The perfor Mance of the Bayes-Stein international portfolio which controls directly for such risk is compared to the perfor Mance of three other international portfolios and the Australian index. The results confirm the existence of those benefits: strategies that control for estimation risk dominate those that do not. Strategies that hedge against foreign currency fluctuations are also found to significantly dominate their unhedged counterpart.