Our model explores the impact of international diversification on domestic investors’ welfares, in particular, with closed-form solutions to asset holdings and utility changes in a simple equilibrium framework wherein agents have mean-variance utility. The model is able to yield the welfare losses of domestic investors by market integration when they have inefficient portfolios before
integration. According to our results, only the efficient portfolio holdings of domestic investorsbefore integration guarantee the welfare enhancement of all domestic investors. This is in contrast to the extant literature that stresses only the beneficial effect of international diversification. In addition, the model enables us to sort out the welfare changes of domestic investors into the correlation effect and the quantity-volatility effect.
Key words: international diversification, welfare loss, correlation effect, quantity/volatility effect
