Homemade international diversification under economic policy uncertainty

Abstract

We examine how US mutual funds that invest domestically make portfolio adjustments by incorporating USlisted foreign stocks (cross-listed stocks) when faced with US market economic policy uncertainty. We document a positive association between US economic policy uncertainty and US mutual funds' weight of cross-listed stocks, and find that the effect is concentrated in funds that mainly invest in the US domestic market. The findings are not sensitive to the instrumental variable approach, model specification, sampling, variable definition, and controlling for macro characteristics. Funds with higher weight of cross-listed foreign stocks when US economic policy uncertainty increases outperform other funds, indicating the rationality of such an investment strategy. A long-short portfolio generates 3.4% annualized abnormal return in the immediate following quarter. Our study shields light not only on the international diversification benefit of US-listed foreign stocks but also on the importance of capital market openness for domestic investors.