Investor Evaluation of Foreign and Domestic Risk

Abstract

In recent years, foreign direct investment by U.S. manufacturing firms has grown rapidly, oriented largely toward markets outside the U.S. Levels of economic activity in these markets are less than perfectly correlated with levels in the U.S. From 1963 on, the U.S. Interest Equalization Tax effectively prevented U.S. portfolio investors from achieving international portfolio diversification directly. Given this contraint, international diversification by firms was of benefit to their owners, by reducing portfolio risk for a given rate of returns.