earlier period 1996-1999. The two-factor model, which includes both home and US market index
returns, indicates that iShares maintain a considerable exposure to the US market. The authors
thus conclude that iShares do not represent a perfect international diversification vehicle.
A similar conclusion is reached by Durand and Scott (2003) in case of Australian iShares.
Durand and Scott use a VAR framework to explain the dynamics of Australian iShares returns
and volume due to movements in U.S. returns, volumes and exchange rates. Their findings
suggest that U.S. based investors into Australian market tend to overreact to contemporaneous
and past information from the U.S. equity market, exchange rates and past iShares returns.
Despite their imperfections, iShares appear to offer diversification potential superior to that
of closed-end country funds. Miffre (2004) demonstrates that investing in iShares may generate
efficiency gains over those achieved by country-specific funds. Relying on the analysis of
optimal portfolios constructed on the basis of Sharpe ratio, the paper argues that a typical investor
would benefit from investing on average half of her wealth in S&P500 and the rest in iShares
tracking developed European markets (Spain, Italy, the U.K., Sweden, Canada and France).
Based on our literature search, Miffre (2004) is the only paper to consider time-varying
correlations between S&P500 and iShares returns. While acknowledging that the correlations are
not stable over time, the author does not attempt to go further and discuss the dynamics of time-
varying correlations and implications for the optimal asset allocation.
In another related paper, Schwebach, Olienyk, and Zumwalt (2002) draw attention to the
impact of increased volatility on the efficacy of diversification. They evaluate performance and
diversification benefits of both WEBS and CECF before and after the Asian crisis. Having
analyzed simple correlations, the paper argues that both performance and extent of diversification
benefits have changed drastically after the Asian crisis, the latter being reflected in increased
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