Inclusion of an International Financial Asset to Diversify the Investment Portfolio in Colombia
Inclusion of an International Financial Asset to Diversify the Investment Portfolio in Colombia

Summary/Abstract: The international diversification of investment portfolios is obtained by including a foreign financial asset and the benefit is the reduction of the market risk of the portfolio. This paper forms a portfolio with five shares of the Colombian market and diversifies it internationally with the Exchange Traded Fund (ETF) of the US market. To demonstrate the benefit of international diversification, the VaR (Value at Risk) of the two portfolios is quantified by two parametric methods: variance-covariance method and Monte Carlo simulation method. Volatilities are calculated by the GARCH (1,1) method and the EWMA method. For the Monte Carlo simulation method, the prices of the financial assets are modeled with the Geometric Brownian Motion and for the simulation of correlated values, the Cholesky decomposition is used. The results show that the ETF has lower risk than the local shares and has lower correlations with the shares generating lower VaR. In other words, the internationally diversified investment portfolio has lower risk than the locally diversified portfolio.

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