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1. Introduction
It is a well-documented fact that portfolio investment across national borders brings diversification benefits of increasing returns and/or reducing risk. These perceived advantages are construed by Bartram and Dufey (2001) as vital motivations engaged with international portfolio investments.
The primary appeal of foreign investments relies on their potential for higher returns per unit of risk. Harvey (1995) indicates that including the so-called emerging equity markets in an optimally diversified portfolio intensely increase expected returns. Emerging economies are more risky than the developed economies, but the former experience higher economic growth that offers opportunities to generate higher returns in internationally diversified portfolios (Butler et al., 1995; Butler and Joaquin, 2002; Gottschalk, 2005; Naranjo and Porter, 2007). Another appeal of foreign investments is the potential for reducing portfolio risk. Emerging equity markets exhibit very low correlation of returns with assets in developed markets (DMs) and due to this, complementing characteristic of emerging markets (EMs) in an international portfolio provides greater diversification benefits than adding only developed (Naranjo and Porter, 2007). This may explain the significant increase in portfolio investment flows into emerging equity markets from only US$15 billion in 2004 to US$197 billion in 2010 (IMF, 2011).
Despite the potential role of emerging countries in providing international portfolio diversification (IPD) benefits, there are two main issues that affect strategies taken by international investors when they include equities from EMs in their portfolio. First, there is a growing degree in co-movement not only across developed and emerging financial markets (Chambet and Gibson, 2008; Phylaktis and Ravazzolo, 2005; Ratanapakorn and Sharma, 2002) but also among some major EMs (Ibrahim, 2006a; 2006b; Markellos and Siriopoulos, 1997; Middleton et al., 2008; Tai, 2007). Also there is an increase in the return volatilities and a decrease in the returns for international investors over the 1994 to 2003 period (Lagoarde-Segot and Lucey, 2007b), probably due to reservation spate of economic and currency crises. These trends could alter the pattern of risk and returns in different economies and the flow of international portfolio capital, which means gaining from mature EMs through IPD has been minimized. In fact, international investors might have to consider new EMs, such as those of the Middle Eastern oil-producing countries, as a potential avenue to seek...