represented about 57 percent, and the U.S. stocks represented 43 percent
of this world portfolio based on market values.
The estimation of the best combination of U.S. and foreign stocks is
very dependent on the risk and return assumptions. For example, if for-
eign exchange risk is ignored, as might be justified for an investor or in-
stitution that buys goods in many different countries, so that translation
back to dollars is not necessary, the optimal foreign portfolio rises to 52.6
percent, just slightly short of the 2007 market value weight.
The impact of changes in the risk and return assumptions on the
allocation between U.S. and foreign stocks is shown in Table 10-3. For
every increase of 100 basis points in U.S. expected returns—or fall in ex-
pected returns in the EAFE Index—there is about an 11.1 percentage
point rise in the allocation to U.S. stocks. For every percentage point in-
crease in the expected risk of U.S. returns or decrease in the expected risk
of EAFE returns, the U.S. allocation falls 6.5 percentage points. And a 0.10
increase in the correlation coefficient between EAFE and U.S. returns will
lower the EAFE allocation by just over 2 percentage points.^8CHAPTER 10 Global Investing and the Rise of China, India, and the Emerging Markets 171
(^7) Readers who wish to understand risk-return analysis can go to Richard A. Brealey, Stewart C.
Myers, and Franklin Allen, Principles of Corporate Finance,” 8th ed., New York: McGraw-Hill, 2006.
(^8) The impact of a change in the correlation coefficient is highly nonlinear. If the correlation rises to
0.77, the U.S. allocation will rise over 6 percentage points; if it rises to 0.87, the U.S. share will rise
by over 17 percentage points.
TABLE 10–3
Efficient Portfolio for Varying Assumptions