The e ec o he Eu o on coun y e sus indus y po olio
di e si ica ion
Thomas J. Fla in*
Na ional Uni e si y o I eland, Maynoo h
Abs ac
We examine he ela i e bene i s o indus ial e sus geog aphical
di e si ica ion in he Eu o zone be o e and a e he in oduc ion o he common
cu ency. A p io i, one may expec ha inc eased s ock ma ke co ela ion would
p ecipi a e a mo e om geog aphical owa ds indus ial di e si ica ion. We employ
he empi ical model o Hes on and Rouwenho s bu show ha adop ing a panel da a
app oach is a mo e e icien es ima ion me hod. We ind e idence o a shi in ac o
impo ance; om coun y o indus y. Howe e , his is no exclusi e o he Eu o zone
bu is also p esen o non-EMU Eu opean coun ies. The e o e, und manage s
should pu sue indus ial a he han geog aphical di e si ica ion s a egies.
JEL Classi ica ion: F36, G11, G15.
Keywo ds: Po olio di e si ica ion, indus y and coun y e ec s, Eu o.
* Add ess o co espondence: Dep . o Economics, NUI Maynoo h, Maynoo h, Co. Kilda e,
I eland. Tel: + 353 1 7083369, Fax: + 353 1 7083934, Email: homas. la [email protected]
1. In oduc ion
A undamen al p inciple o inancial heo y, da ing back o Ma kowi z (1952), is
ha po olio di e si ica ion allows an in es o o ea n highe e u ns o each uni o
isk and hence leads o g ea e po olio pe o mance. G ubel (1968) and Le y and
Sa na (1970) we e among he i s o show ha di e si ica ion ac oss in e na ional
asse s inc eased hese bene i s due o hei ela i ely low co ela ion compa ed o
hose o domes ic s ocks. Many empi ical pape s ind ha hese bene i s a e s ill
p esen despi e inc easing in eg a ion ac oss inancial ma ke s in bo h s ock ma ke s
(G aue and Hakansson, 1987; De San is and Ge a d, 1997) and bond ma ke s (Le y
and Le man, 1988) and in he ace o ime- a ying co ela ions (Ang and Bekae ,
2002). Many au ho s ha e posed he ques ion whe he o no equi alen bene i s can
be ob ained om di e si ying po olios ac oss indus ies a he han ac oss na ional
bo de s. The ea ly li e a u e p o ided o e whelming e idence ha in e na ional
di e si ica ion is be e han indus ial di e si ica ion. G ubel and Fadna (1971)
epo ha indus ies wi hin a coun y a e mo e highly co ela ed han indus ies
ac oss coun ies. Howe e , Hes on and Rouwenho s (1994,1995) we e among he
i s pape s o igo ously add ess his issue. They ocus on Eu opean ma ke s - 12 in
o al - and assign each s ock o one o se en indus ial sec o s. Thei main inding was
ha he majo i y o di e si ica ion bene i s s em om in e na ional a he han
indus ial di e si ica ion. They epo ha on a e age less han 4% o he a ia ion in
coun y indexes is a ibu able o hei indus ial composi ion. G i in and Ka olyi
(1998) include de eloped non-Eu opean ma ke s as well as some eme ging ma ke s,
while allowing o “mo e inely pa i ioned indus ial classi ica ions” bu ind no
g ea e impo ance o indus y e ec s in po olio selec ion. Rouwenho s (1999)
again ocuses on Eu opean coun ies o e he pos Maas ich T ea y ime pe iod up o
Augus 1998 and inds ha he ela i e s eng hs o coun y e ec s is una ec ed by
ime and inc eased economic in eg a ion. Mo e ecen s udies ha e been less
suppo i e o he iew ha coun y e ec s domina e indus ial sec o al e ec s. B ooks
and Ca ao (2000) es ima e he impac o ‘new-economy’ e sus ‘old-economy’ s ocks
in po olio di e si ica ion and ind ha he in oduc ion o ‘new-economy’ s ocks
inds an inc eased ole o di e si ica ion ac oss indus ial sec o s. Baca e al. (2000)
also epo an inc eased ole o sec o al e ec s in de e mining asse e u ns and
conclude ha coun y e ec s ha e declined in impo ance. Thei ocus is on he se en
1
la ges wo ld s ock ma ke s so he e o e you may expec ela i ely high le els o
in eg a ion. Mo eo e , Ca aglia e al. (2000), using an ex ended sample o coun ies,
ag ee wi h his inding and s a e ha o he pu poses o po olio isk educ ion,
indus ial ac o s a e mo e impo an han coun y e ec s. Recen s udies on eme ging
ma ke s ha e iden i ied a simila pa e n wi h Wang e al. (2003) inding ha
indus ial e ec s ha e been signi ican ly mo e impo an han coun y e ec s in Asian
ma ke s since a leas 1999.
Un il now, s udies ocussing on Eu ope ha e ound ha indus ial composi ion
plays a ela i ely mino ole in de e mining coun y co ela ions and ha low
co ela ions a e p ima ily due o coun y-speci ic sou ces o e u n a ia ion. This
pape ocuses on he de e mina ion o c oss-coun y co ela ion and hence on he
op imal po olio di e si ica ion s a egy om he pe spec i e o an in es o om a
Eu o zone coun y. In pa icula , we assess he ela i e impo ance o coun y- and
indus y-speci ic shocks o he a iabili y o s ock e u ns. The e a e a numbe o
legi ima e easons o a e-examina ion o his issue.
Fi s ly, om a inancial ma ke s pe spec i e, he e has been su icien change in
he in es men landscape o wa an u he in es iga ion. In he a e ma h o he
in oduc ion o i e ocably ixed exchange a es be ween membe coun ies on
Janua y 1, 1999, a ypical in es o who wan s o hold a po olio wi hou o eign
exchange isk has had hei in es men oppo uni y se al e ed signi ican ly. The
po olio se has been expanded eno mously as all Eu o zone in es o s may di e si y
ac oss in e na ional bo de s be ween pa icipa ing s a es wi hou wo ying abou
cu ency luc ua ions. Boda and Reding (1999) ound ha exchange a e isk educes
ma ke in eg a ion. O cou se, he magni ude o he bene i s o inc easing he
in es men se will be dic a ed by he co ela ions be ween s ocks in hese coun ies.
The e a e likely o be la ge isk- e u n bene i s o be eaped i he p e iously obse ed
low coun y co ela ions a e main ained. Howe e some o he ex book explana ions
o low co ela ion no longe apply o he Eu o zone coun ies, such as di e ences in
iscal and mone a y policies. All s a es ha e now ans e ed esponsibili y o
mone a y policy om domes ic cen al banks o he Eu opean Cen al Bank (ECB),
while he deg ee o iscal au onomy among membe coun ies has also been
d ama ically educed. This policy co-o dina ion has led o a subs an ial na owing o
in e es a es ac oss he Eu o zone coun ies. We should expec ha inc eased
2
economic in eg a ion would educe he asymme y o esponses o shocks o
undamen al a iables. Fu he mo e, ew ins i u ional o legal impedimen s emain.
Consequen ly, one migh expec ha c oss-coun y co ela ions would be mainly
d i en by di e ences in he indus ial s uc u e o domes ic ma ke s. The e o e, i is
easonable o expec ha di e si ica ion ac oss indus ies may be mo e impo an in
his new e a, especially since Ca ie i e al. (2004) ind ha inc eased coun y le el
in eg a ion does no ule ou indus y-le el segmen a ion. Howe e , he e a e a
numbe o ac o s ha could wo k in he opposi e di ec ion. Goe zmann e al. (2002)
ind ha episodes o in eg a ion a e no only cha ac e ised by inc eased c oss-coun y
co ela ion bu also by an expansion o he in es men oppo uni y se . The la e
e ec may o e imp o ed in es men di e si ica ion possibili ies. Ano he compe ing
iew comes om F ancis e al. (2002) who show ha abo e a e age le els o
cu ency ola ili y leads o inc eased s ock ma ke co ela ion, so i is possible ha he
e ec o elimina ing exchange a e a iabili y could esul in lowe co ela ion
be ween ma ke s. The adop ion o he Eu o p o ides as nea o a na u al expe imen
as you a e likely o ind in inancial economics and allows us o assess he po en ial
explana ions o low c oss-coun y co ela ions men ioned abo e.
Secondly, om an econome ic iewpoin , we also apply mo e e icien es ima ion
echniques o he model han hose usually employed. In pa icula , we o m a panel
da a se and show ha pooling he da a and es ima ing a c oss-sec ion o ime se ies
eg ession leads o mo e p ecise es ima ion. This allows us o a ach s a is ical as well
as economic signi icance o ou esul s and has impo an implica ions o und
manage s in making hei decision whe he o pu sue ac i e geog aphical o indus ial
di e si ica ion.
We ind ha he e has been a shi in impo ance om coun y o indus ial
e ec s. In he ea ly yea s o ou sample, ou esul s a e consis en wi h he o he
li e a u e ocussing on Eu opean s ock ma ke s; coun y e ec s ou weigh indus ial
e ec s. Howe e his esul is e e sed ollowing he in oduc ion o he Eu o.
The e o e Eu o zone in es men s a egies would be be e o concen a ing on
indus ial a he han geog aphical di e si ica ion. This is consis en wi h inc eased
in eg a ion be ween Eu o zone ma ke s a e he adop ion o he single cu ency,
which has been documen ed by F a zsche (2001). Howe e , we use a g oup o non-
EMU Eu opean coun ies o show ha his esul is no jus con ined o he Eu o zone.
3
The obus ness o ou esul s o he inclusion o hese addi ional ma ke s sugges s ha
he decline in impo ance o coun y e ec s may be due o ac o s o he han he
in oduc ion o he Eu o. In pa icula , when aken wi h he o he li e a u e, inc eased
coun y co ela ions appea o be a global phenomenon. The emainde o he pape is
o ganised as ollows. Sec ion 2 e iews he li e a u e on he sou ces o low c oss-
coun y co ela ion and analyses whe he hese a e likely o apply wi hin he common
cu ency a ea. Sec ion 3 desc ibes he da a while sec ion 4 ou lines he model and
discusses i s es ima ion. Ou esul s a e p esen ed in sec ion 5, while conclusions a e
con ained in sec ion 6.
2. Sou ces o low c oss-coun y co ela ion
Gi en i s impo ance in po olio selec ion models, he sou ces o low c oss-
coun y co ela ion o inancial asse e u ns ha e gene a ed a g ea deal o li e a u e.
A numbe o common hemes ha e eme ged.
Fi s ly, a po en ial explana ion o low co ela ion may be due o low le els o
ma ke in eg a ion. In segmen ed o pa ially segmen ed ma ke s local ac o s may be
mo e impo an han global ac o s. Wi hou ull in eg a ion, i is possible o obse e
p icing di e ences o di e en speeds o p ice adjus men . The e is empi ical
e idence o show ha s ock ma ke co ela ion is posi i ely linked o le els o bo h
economic and inancial in eg a ion. Fe son and Ha ey (1991) ind a posi i e
ela ionship be ween he deg ee o eal and inancial in eg a ion. Bekae and Ha ey
(1995) show ha ma ke in eg a ion has a s ong in luence on he co-mo emen o
eme ging ma ke e u ns wi h a global ma ke ac o . Fu he mo e, he e is e idence
o ma ke in eg a ion inc easing o e ime (De San is and Ge a d, 1997 and
Ha dou elis e al., 1999). Reduc ions in ansac ion cos s, ins i u ional and legal
impedimen s a e gene ally c edi ed wi h inc easing in eg a ion among de eloped
ma ke s. Following he subs an ial poli ical, economic and inancial co-o dina ion
wi hin he Eu o zone, s ock ma ke co-mo emen s a e unlikely o be low o lack o
ma ke in eg a ion.
Howe e , s ock ma ke in eg a ion may s ill be es ic ed by he home bias in
equi y po olios displayed by many in es o s (see Lewis, 1999 o a e iew o his
opic). One possible explana ion o his phenomenon is ha in es o s a e be e
in o med abou domes ic (o egional) ma ke condi ions o hey a e mo e op imis ic
4

abou he u u e pe o mance o domes ic ma ke s (in es o sen imen ). Fla in e al.
(2003) show ha geog aphical a iables, which may be a p oxy o hese
psychological ba ie s, ha e signi ican explana o y powe o de e mining he le el
o s ock ma ke co ela ion.
Secondly, ollowing Roll (1992), di e ences in he indus ial composi ion o
na ional indices ha e been pu o wa d as an impo an de e minan o c oss-coun y
co ela ion. Howe e , mo e ecen empi ical e idence does no suppo his iew.
Hes on and Rouwenho s (1994,1995), G i in and Ka olyi (1998) and Fla in e al.
(2003) all show ha indus ial composi ion explains li le o s ock ma ke co-
mo emen s.
Thi dly, economic undamen als and economic shocks may also play a ole in
de e mining s ock ma ke co ela ion. Campbell and Hamao (1992) show ha
economic undamen als, such as in e es a es and di idend yields, help o explain US
and Japanese ma ke co-mo emen . Con e sely, Ka olyi and S ulz (1996) ind li le
e idence ha mac oeconomic announcemen s o shocks o exchange a es o in e es
a es in luence U.S. and Japanese s ock e u n co ela ions. Amme and Mei (1996)
ind ha equi y isk p emia a he han undamen al a iables accoun o mos co-
mo emen s ac oss na ional indices. Ob iously, coun y-speci ic shocks will impac on
domes ic ma ke e u ns and hence educe co-mo emen s wi h o he ma ke s, bu also
global shocks o which ma ke s ha e di e en sensi i i ies may also esul in low
c oss-coun y co ela ion.
Wi h he co-o dina ion o mone a y a iables wi hin he Eu o zone, he main ocus
o ou pape is o examine he ole o economic shocks, he inal explana ion ou lined
abo e. In pa icula we seek o assess he ela i e impo ance o coun y- and
indus y-speci ic shocks. The deg ee o which such shocks ha e di e en ial c oss-
coun y and c oss-indus y e ec s may help o iden i y he op imal di e si ica ion
s a egy a ailable o a po olio manage .
3. Da a
We use mon hly o al e u ns and ma ke capi alisa ions on 1193 companies ac oss
he ele en o iginal membe s o he ‘Eu o zone’. G eece is omi ed om he analysis,
as i did no join he EMU on Janua y 1999. A con ol g oup is c ea ed using simila
da a o he UK, Swi ze land, Denma k and Sweden. All e u ns a e exp essed in a
5
common cu ency, he Eu o. P e-Eu o e u ns o all ma ke s and pos -Eu o e u ns
o he non-EMU coun ies a e compu ed by con e ing om he domes ic cu ency o
he Eu o ia he ECU end-o -mon h exchange a e. Ou sample s e ches om Janua y
1995 o Decembe 2002. The s a ing poin was chosen o gi e an equal span be o e
and a e he in oduc ion o he Eu o. In his espec , we hope o cap u e changes in
op imal di e si ica ion s a egies ha may ha e been induced by he adop ion o he
common cu ency. All da a a e collec ed om Da as eam and each company is
assigned o an indus ial sec o and a coun y acco ding o he Da as eam
classi ica ion. These a e consis en wi h he FTSE indus y sec o s. In his applica ion,
we use en b oad indus ial classi ica ions. G i in and Ka olyi (1998) ha e al eady
shown ha using e y ine indus y de ini ions does no signi ican ly change he
indings. Gi en ha we a e ying o assess he impac o he in oduc ion o he
common cu ency, we ha e decided o wo k wi h a balanced panel o companies. Fo
he Eu o zone, his lea es us wi h 740 companies. The indus ial and geog aphical
b eakdown o hese companies is epo ed in Table 1. I is clea ha he e is a non-
uni o m dis ibu ion o companies ac oss indus ial sec o s and especially ac oss
geog aphical bounda ies, e.g. Luxembou g has ela i ely ew s ocks and hese end o
be concen a ed in he inancial sec o , whe eas Ge many accoun s o almos 20% o
he companies in ou sample bu 75% o hese ope a e ou side o he inancial sec o .
Table 2 p esen s in o ma ion on he a e age ma ke capi alisa ion o he i ms in
ou sample. In pa icula , we epo he a e age p opo ion o he Eu o zone ma ke
ha is a ibu able o each coun y and each sec o o e he whole sample. Again we
see impo an di e ences ac oss coun ies and indus ial sec o s. In o ma ion
echnology s ocks accoun ed o abou 7% o he Eu o zone alue-weigh ed index bu
almos 40% o hese we e loca ed in Finland (mainly Nokia). These s ocks
ep esen ed o e 60% o he Finnish ma ke . The highes alue weigh s o Ge man
s ocks a e in Financials and Indus ial i ms, while F ance has a highe concen a ion
o Se ice p o iding companies.
Tables 3 and 4 p esen sample co ela ions o he Eu o zone coun ies and
indus ies espec i ely. These co ela ions a e compu ed using mon hly e u ns o he
p e- and pos -Eu o pe iod. Ini ially, ocusing on he coun y co ela ions, we can see
ha he e is signi ican a ia ion be ween he samples. The a e age pai -wise
co ela ion alls om 0.679 in he p e-Eu o sample o 0.586 in he pos -Eu o sample.
6
This is coun e -in ui i e gi en ha we would ha e expec ed he co ela ion o ise in
ligh o he inc eased in eg a ion wi hin his economic zone. Howe e , his inding is
consis en wi h Adjaou é and Dan hine (2004) who a gue ha his could be due o he
cyclical na u e o coun y co ela ion. We would equi e an ex ended pos -Eu o
sample o e i y his. Ano he po en ial explana ion is ha EMU has c ea ed e en
g ea e e u n dispe sion h ough an expansion o he in es men oppo uni y se as
sugges ed by Goe zmann e al. (2002), he eby o se ing he in eg a ion e ec wi h
new di e si ica ion possibili ies. Al e na i ely, i may be ha he elimina ion o
cu ency ola ili y has lowe ed equi y ma ke co ela ion, in line wi h F ancis e al.
(2002). The alling a e age co ela ion does mask he ac ha o e 38% (21 ou o
55) o he co ela ions did inc ease. Table 4 con ains he co esponding ma ix o he
Eu o zone indus ies. He e we see a ela i ely la ge dec ease in he a e age pai -wise
co ela ion, om a p e-Eu o le el o 0.747 o 0.568 in he pos -Eu o sample. A
dec ease in co ela ion was eco ded in 38 o he 45 (nea ly 85%) co ela ion
coe icien s. I is no ewo hy ha he a e age co ela ion is highe o indus ies han
coun ies in he o me ime pe iod and sligh ly lowe in he la e pe iod. This
sugges s ha he e may ha e been a ela i e shi o , a leas , con e gence in coun y
and indus y e ec s o e he sample.
Equi alen co ela ions o he non-EMU sample a e bo h cha ac e ised by
inc easing co ela ion. A e age co ela ions ha e inc eased om 0.668 o 0.704 o
coun ies and 0.428 o 0.453 o indus ies. I is no iceable ha all pai -wise c oss-
coun y co ela ions a e much highe han hose o indus ies. These co ela ions a e
p esen ed in Tables 5 and 6.
4. Me hodology
Hes on and Rouwenho s (1994) p opose a model o s ock e u n ha is capable o
disen angling coun y and indus y e ec s. Solnik and de F ei as (1988) allow o
exchange a e e ec s, bu his is clea ly edundan in ou speci ica ion. The e u n o
any s ock i ha belongs o indus y j and coun y k is gi en by:
.
i kji
R






 (1)
7
In his o mula ion, α ep esen s a common componen o all s ocks, βj
cap u es he indus y e ec and γk he coun y e ec . The e o e m, εi, is asse
speci ic and is assumed o be ze o mean wi h a ini e a iance. This speci ica ion ules
ou any in e ac ion be ween indus y and coun y e ec s. Using ou da a, we ha e
companies loca ed in one o ele en coun ies (k = 1 o 11), wi h each belonging o one
o en indus ies (j = 1 o 10). We de ine indus y dummies, Iij, o ha e a alue o one
i s ock i belongs o indus y j and ze o o he wise. Likewise, coun y dummies, Cik,
ake a alue o one i s ock i belongs o coun y k and ze o o he wise. Thus we can e-
w i e equa ion (1) o each ime pe iod as
...... 111111101011 i iiiii CCIIR










 (2)
O cou se, equa ion (2) canno be es ima ed in i s cu en o m as bo h he
indus y and coun y dummies sum o uni y, esul ing in pe ec mul icollinea i y
be ween he eg esso s. We could p oceed by d opping an a bi a y indus y and
coun y and measu ing e e y hing else ela i e o hese. Howe e o po olio
manage s, i would be mo e desi able o measu e coun y and indus y e ec s ela i e
o some mo e easily iden i iable and accep ed benchma k such as an equally (o
alue)-weigh ed index o s ocks. Hes on and Rouwenho s (1994) ollow Sui s (1984)
and Kennedy (1986) by es ima ing a cons ained dummy a iable eg ession. In
essence, his amoun s o cons aining he weigh ed indus y and coun y e ec s o
sum o ze o. Imposing such es ic ions is equi alen o measu ing each indus y
ela i e o he a e age i m o in his case a weigh ed po olio o Eu o zone s ocks. I
we appo ion he weigh s simply as he numbe o s ocks in each coun y and
indus y, hen ou benchma k is an equally weigh ed index.






11
1
10
1
0
,0
kkk
j
jj
m
n


(3)
whe e nj and mk ep esen he numbe o i ms in indus y j and coun y k
espec i ely.
8
ad oca ed as a bene i o EMU, i could be a gued ha his may accoun o some o
he inc ease in impo ance o indus y e ec s wi hin he single cu ency zone.
B ooks and Ca ao (2000) a gue ha he inc easing impo ance o he indus y
ac o in hei s udy could be due o he In o ma ion Technology sec o . I is gene ally
accep ed ha he e was a bubble in his sec o du ing he la e-90’s, being uelled by
in e ne companies in he main. Howe e , in ou analysis, we a e dealing wi h a
balanced panel and he e o e only include hose s ocks o which a ull his o y om
1995-2002 is a ailable. The e o e he in luence o sho -li ed, mis-p iced companies
is g ea ly educed, i no o ally elimina ed.
An al e na i e explana ion o he inc eased impo ance o indus y ac o s s ems
om he cyclical beha iou o coun y e ec s (Adjaou é and Dan hine, 2004). The
decline in coun y ac o s may be empo a y and i so und manage s should be
ca e ul abou he absolu e adop ion o indus ial s a egies. P esen ly such s a egies
seem o o e be e di e si ica ion possibili ies bu in so a as coun y ac o s a e
cyclical, his could be e e sed again.
6. Conclusion
The goal o ou pape is o assess he ela i e impo ance o coun y and indus y
e ec s in Eu opean po olio di e si ica ion and he impac o he Eu o on his. Many
ea lie s udies ha e add essed his issue and gene ally, o Eu opean ma ke s,
concluded ha coun y e ec s we e g ea e and consequen ly di e si ica ion along
geog aphical lines was mo e impo an o und manage s. Ou mo i a ion o
unde aking his analysis is wo- old. Fi s ly, his is he i s s udy o ocus exclusi ely
on he Eu o zone ma ke s in he pos -EMU pe iod. The elimina ion o o eign
exchange isk li ed ba ie s o in es o s who a e a e se o his isk sou ce and as
such p o ided a much-expanded ‘domes ic’ ma ke . The adop ion o a common
mone a y policy and he g ea e alignmen o iscal policy ac oss membe s a es,
oge he wi h ew legal o ins i u ional ba ie s o in es men se ed o educe many
o he usual explana ions o low c oss-coun y co ela ion. One emaining plausible
explana ion is ha low s ock ma ke co-mo emen s ems om he di e ing indus ial
composi ion o he indexes. The e o e, a p io i, one migh expec ha wi hin his
egion indus ial e ec s may play a mo e impo an ole in po olio choice in he
a e ma h o he Eu o being adop ed. Secondly, we apply panel da a es ima ion
15

echniques ha imp o e he e iciency o ou esul s. Compa ed o he mo e
adi ional es ima ion app oach, we a e able o a ach s a is ical as well as economic
signi icance o ou esul s.
Using da a on he Eu o zone ma ke s om 1995-2002, ou indings sugges ha in
he pu ely pos -Eu o sample indus y e ec s ou weigh coun y e ec s and hence
indus ial di e si ica ion is mo e likely o con e g ea e po olio pe o mance on he
in es o . On a e age, co ela ions be ween na ional s ock ma ke s in his a ea ha e
dec eased bu by less han c oss-indus y co ela ions. I is also no ewo hy ha
co ela ions is-à- is he la ge ma ke s ac ually inc eased. Now, indus ial po olios
appea o be less co ela ed han coun y po olios. Indus y-speci ic shocks c ea e
mo e e u n dispe sion han coun y-speci ic shocks and hence o e g ea e po olio
di e si ica ion bene i s.
Howe e , u he analysis e eals ha his change in he ela i e impo ance o
coun y and indus y e ec s is no exclusi e o he Eu o zone. In ac , i is also o be
ound in a sample o non-EMU Eu opean coun ies whe he analysed sepa a ely o in
a la ge pan-Eu opean sample. The e o e we conclude ha his e e sal in he ela i e
o unes o coun y and indus y di e si ica ion is no due o he in oduc ion o he
common cu ency bu is pa o a global phenomenon ha has also been documen ed
o o he egions. Consequen ly, po olio manage s would be well ad ised o adop
di e si ica ion s a egies based on indus y po olios a he han coun y po olios.
A numbe o explana ions o he epo ed inc ease in he impo ance o
indus y e ec s a e sugges ed. Fi s ly, global ma ke condi ions since 1999 ha e been
u bulen wi h a numbe o inancial c ises and he c ash ollowing Sep embe 11,
2001. Such e en s gene ally end o inc ease s ock ma ke co-mo emen s. Secondly,
indus y-speci ic shocks could become a mo e impo an sou ce o e u n a ia ion as
some indus ies become mo e exposed o in e na ional ade. Thi dly, Adjaou é and
Dan hine (2004) sugges ha he decline in coun y e ec s may be due o hei
cyclical beha iou . A longe pos -Eu o sample will be needed o e i y his.
16
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19
Panel A
TOTLF NCYSRCYSER NCYCGCYCGDGENIN BASIC ITECH RESOR UTILS TOTAL
OE 10 0 2 5 0 5 7 0 1 2
32
BG 18 5 3 1 0 9 8 2 0 1
47
LX 13 0 2 2 0 0 1 0 0 3
21
FN 3 1 7 5 1 9 9 2 0 1
38
FR 26 6 36 20 17 12 13 9 6 0
145
BD 35 3 8 21 18 24 19 1 0 7
136
IR 6 0 6 9 1 1 8 0 6 0
37
IT 35 4 5 2 10 13 14 1 2 0 86
NL 22 5 18 10 8 11 9 2 7 0 92
ES 23 7 6 7 4 7 15 0 2 5 76
PT 6 4 7 3 1 3 6 0 0 0
30
197 35 100 85 60 94 109 17 24 19 740
Panel B
UK 122 9 121 32 8 31 41 14 13 9 400
SW 33 2 13 12 6 18 9 2 0 6
101
DK 13 1 8 10 0 3 1 0 0 0
36
SK 11 0 3 4 2 11 9 3 0 0 43
179 12 145 58 16 63 60 19 13 15 580
Table 1: Panel A (B): Numbe o Companies in Balanced Eu o zone (Non-EMU)
Panel by Indus ial Sec o and Coun y.
Key: OE = Aus ia, BG = Belgium, LX = Luxembou g, FN = Finland, FR = F ance,
BD = Ge many, IR = I eland, IT = I aly, NL = Ne he lands, ES = Spain, PT =
Po ugal, UK = Uni ed Kingdom, SW = Swi ze land, DK = Denma k, SK = Sweden,
TOTLF = Financials, NCYSR = Non-cyclical Se ices, CYSER = Cyclical Se ices,
NCYCG = Non-cyclical Consume goods, CYCGD = Cyclical Consume goods,
GENIN = Gene al Indus ials, BASIC = Basic Indus ials, ITECH = In o ma ion
Technology, RESOR = Resou ces, UTILS = U ili ies.
20

TOTLF NCYSRCYSER NCYCGCYCGDGENIN BASIC ITECH RESOR UTILS TOTAL
OE 0.0029 0.0002 0.0004 0.0005 0.0002 0.0007 0.0015 0.0000 0.0008 0.0009 0.0081
BG 0.0177 0.0019 0.0016 0.0031 0.0002 0.0025 0.0037 0.0002 0.0000 0.0066 0.0374
LX 0.0028 0.0000 0.0013 0.0000 0.0000 0.0000 0.0002 0.0000 0.0000 0.0001 0.0045
FN 0.0019 0.0035 0.0010 0.0017 0.0001 0.0019 0.0054 0.0263 0.0007 0.0001 0.0427
FR 0.0394 0.0331 0.0293 0.0409 0.0177 0.0311 0.0185 0.0218 0.0244 0.0013 0.2575
BD 0.0722 0.0295 0.0125 0.0139 0.0259 0.0447 0.0259 0.0167 0.0003 0.0066 0.2482
IR 0.0063 0.0000 0.0014 0.0042 0.0002 0.0000 0.0027 0.0000 0.0002 0.0000 0.0151
IT 0.0520 0.0312 0.0103 0.0016 0.0086 0.0053 0.0023 0.0006 0.0141 0.0093 0.1354
NL 0.0489 0.0126 0.0163 0.0188 0.0023 0.0111 0.0059 0.0050 0.0345 0.0000 0.1553
ES 0.0278 0.0181 0.0042 0.0022 0.0009 0.0017 0.0055 0.0000 0.0057 0.0149 0.0811
PT 0.0052 0.0046 0.0009 0.0001 0.0001 0.0001 0.0016 0.0000 0.0000 0.0021 0.0148
0.2773 0.1346 0.0792 0.0871 0.0562 0.0992 0.0733 0.0706 0.0805 0.0421 1.0000
Table 2: Pe cen age o Value-weigh ed index by Indus y and Coun y.
Key: OE = Aus ia, BG = Belgium, LX = Luxembou g, FN = Finland, FR = F ance,
BD = Ge many, IR = I eland, IT = I aly, NL = Ne he lands, ES = Spain, PT =
Po ugal, TOTLF = Financials, NCYSR = Non-cyclical Se ices, CYSER = Cyclical
Se ices, NCYCG = Non-cyclical Consume goods, CYCGD = Cyclical Consume
goods, GENIN = Gene al Indus ials, BASIC = Basic Indus ials, ITECH =
In o ma ion Technology, RESOR = Resou ces, UTILS = U ili ies.
21
PRE-EURO
OE BG FN FR BD IR IT LX NL PT ES
OE 1.000
BG 0.738 1.000
FN 0.648 0.666 1.000
FR 0.760 0.828 0.562 1.000
BD 0.807 0.807 0.675 0.797 1.000
IR 0.674 0.642 0.711 0.627 0.734 1.000
IT 0.644 0.768 0.547 0.777 0.638 0.579 1.000
LX 0.628 0.621 0.457 0.564 0.541 0.550 0.604 1.000
NL 0.821 0.819 0.693 0.856 0.878 0.731 0.704 0.558 1.000
PT 0.759 0.625 0.508 0.776 0.628 0.573 0.661 0.465 0.686 1.000
ES 0.705 0.702 0.627 0.757 0.727 0.702 0.725 0.611 0.748 0.686 1.000
POST-EURO
OE BG FN FR BD IR IT LX NL PT ES
OE 1.000
BG 0.568 1.000
FN 0.021 0.122 1.000
FR 0.336 0.621 0.716 1.000
BD 0.438 0.631 0.611 0.946 1.000
IR 0.361 0.608 0.346 0.645 0.669 1.000
IT 0.267 0.498 0.593 0.862 0.834 0.526 1.000
LX 0.384 0.411 0.317 0.679 0.732 0.534 0.678 1.000
NL 0.497 0.735 0.560 0.905 0.899 0.723 0.832 0.679 1.000
PT 0.079 0.410 0.508 0.728 0.721 0.433 0.719 0.561 0.618 1.000
ES 0.375 0.576 0.499 0.832 0.830 0.669 0.767 0.605 0.797 0.735 1.000
Table 3. Co ela ion Ma ix o Eu o zone coun ies p e- and pos -Eu o.
Key: OE = Aus ia, BG = Belgium, LX = Luxembou g, FN = Finland, FR = F ance,
BD = Ge many, IR = I eland, IT = I aly, NL = Ne he lands, ES = Spain, PT =
Po ugal
22
PRE-EURO
TOTLF
N
CYS
R
C
YSE
R
N
CYCG
C
YCGD GENIN
B
ASIC
I
TECH
R
ESOR
R
ESOR
TOTLF 1.000
N
CYSR 0.784 1.000
CYSER 0.789 0.851 1.000
N
CYC
G
0.818 0.846 0.875 1.000
CYCGD 0.833 0.859 0.855 0.874 1.000
GENIN 0.896 0.867 0.887 0.917 0.930 1.000
BASIC 0.810 0.795 0.878 0.870 0.914 0.932 1.000
ITECH 0.805 0.756 0.743 0.692 0.802 0.825 0.773 1.000
RESOR 0.591 0.575 0.649 0.632 0.742 0.692 0.700 0.500 1.000
UTILS 0.534 0.663 0.606 0.564 0.580 0.584 0.557 0.423 0.573
POST-EURO
TOTLF
N
CYS
R
C
YSE
R
N
CYCG
C
YCGD GENIN
B
ASIC
I
TECH
R
ESOR
R
ESOR
TOTLF 1.000
N
CYSR 0.517 1.000
CYSER 0.761 0.773 1.000
N
CYC
G
0.630 0.070 0.301 1.000
CYCGD 0.786 0.459 0.715 0.432 1.000
GENIN 0.850 0.698 0.917 0.389 0.795 1.000
BASIC 0.800 0.429 0.710 0.454 0.834 0.786 1.000
ITECH 0.707 0.832 0.817 0.272 0.614 0.841 0.606 1.000
Table 4. Co ela ion Ma ix o Eu o zone Indus ial Sec o s p e- and pos -Eu o.
Key: TOTLF = Financials, NCYSR = Non-cyclical Se ices, CYSER = Cyclical
Se ices, NCYCG = Non-cyclical Consume goods, CYCGD = Cyclical Consume
goods, GENIN = Gene al Indus ials, BASIC = Basic Indus ials, ITECH =
In o ma ion Technology, RESOR = Resou ces, UTILS = U ili ies.
23
1995-1998
UK SW DK SK
UK 1
SW 0.639548 1
DK 0.728706 0.657548 1
SK 0.677344 0.690473 0.616662 1
1999-2002
UK SW DK SK
UK 1
SW 0.790238 1
DK 0.685414 0.677749 1
SK 0.731875 0.632709 0.708063 1
Table 5. Co ela ion Ma ix o non-EMU coun ies p e- and pos -Eu o.
Key: UK = Uni ed Kingdom, SW = Swi ze land, DK = Denma k, SK = Sweden.
24
End S a Jan 95 Jan 96 Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02
Dec 95 0.5720
Dec 96 0.5258 0.5202
Dec 97 0.5263 0.7019 0.6522
Dec 98 1.6243 1.2697 1.0905 1.5573
Dec 99 1.4045 1.4199 1.3717 1.3483 0.9530
Dec 00 0.8722 0.8773 0.7136 0.6711 0.6612 1.7161
Dec 01 0.6223 0.3946 0.4395 0.4170 0.6440 2.4733 1.2010
Dec 02 0.9368 0.6274 0.8083 1.0230 1.1898 1.8569 1.2757 1.0803
Table 11: Ra io o indus y o coun y e ec s based on balanced panel o 1320
companies om Eu ope.
31

32
End S a Jan 95 Jan 96 Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02
Dec 95 0.9634
Dec 96 0.8009 0.6040
Dec 97 0.5914 0.7677 0.6771
Dec 98 1.5275 1.3004 0.9431 1.3616
Dec 99 1.8263 1.3265 1.1920 1.3552 0.9742
Dec 00 0.9459 0.6075 0.4563 0.5112 0.5422 1.9693
Dec 01 0.7637 0.3163 0.2858 0.4332 0.6872 1.9958 0.7769
Dec 02 0.7212 0.3911 0.5626 0.7751 1.0943 1.7869 1.0350 0.9891
Table 12: Ra io o indus y o coun y e ec s based on balanced panel o 543
companies om EMU excluding inancials.