The relative strengths of industry versus country factors can be of major importance for global equity
portfolio managers. If country effects dominate, then primary consideration can be given to the country
allocation decision. On the other hand, if global economic integration is reducing the distinctions
between countries, then an industry-first investment process may be more appropriate.
One early study of the relative strength of industries versus countries was provided by Grinold, Rudd,
and Stefek (1989). They regressed monthly local excess returns (currency hedged) against a set of global
factors that included 24 countries, 36 industries, and four styles. They showed that country factors had
higher statistical significance and greater explanatory power than industry factors over the period 1983-
Heston and Rouwenhorst (1995) also investigated the question of industries versus countries, but
focused instead on developed Europe. They regressed monthly stock returns (in German marks) against
a set of 7 industry factors and 12 European countries. Using equal-weighted regression (i.e., ordinary
least squares), they found that country factors were more volatile than their industry counterparts over
the time period 1978-1992.
In a subsequent study, Rouwenhorst (1999) performed monthly cap-weighted regressions of developed
European stock returns (in German marks) against a set of 7 industry factors and 12 country factors
during the sample period 1978-1998. He found that country factors were more volatile than industry
factors over the 20-year sample period. He also introduced mean absolute deviation (MAD), given by the
cap-weighted mean absolute factor return, as a way to measure the relative strength of industries
versus countries. Using this measure, Rouwenhorst once again found that countries in developed
Europe consistently dominated industries during the period 1978-1998.
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