The role of country and industry factors during volatile times

• The empirical evidence shows mixed results regarding the relative importance of the country and industry effects.
• The results point to the fact that the country effect no longer dominates the industry effect.
• We show that the country and industry effects can effectively be evaluated over time.
• We note that in the early part of the sample period the country effect dominates the industry effect.

Global stock market investment has highlighted the debate about whether country effects are typically more relevant than sector/industry effects in international stock returns. This paper studies the roles of country and industry effect on several major European financial markets. We find clear evidence that diversification over industries yields fundamental relevance for obtaining more efficient portfolios, and that ignoring the industrial mix leads to an important loss of diversification benefits. In addition we examine the behavior of country and industry effects during high (low) volatility periods. Alluring investors to diversify across industries requires a country to industry effect ratio to be substantially lower during high than low volatility periods. The fact that countries tend to move together during volatile periods posits that industry diversification may provide relatively more protection in crisis. For the entire time span we find that industries provide better protection in times of high volatility relative to countries. However, countries do perform better in absolute terms. Finally, we conclude that investors seeking global representation in their investment portfolios should continue to consider diversifying broadly across both countries and industries. Our findings have important implications for international portfolio diversification.