Country Versus Industry Diversification in ASEAN-5

This paper examines the role of common, country, and industry effects on international diversification potential in ASEAN (Association of Southeast Asian Nations) stock markets. Following a decomposition approach, we extract these effects from stock returns and further examine the determinants of country effects using International Country Risk Guide indexes. Our results indicate that country effects dominate industry effects despite the increasing integration of economic and financial markets. However, a diminishing trend of country effects domination coupled with improving fundamentals in ASEAN-5 was observed during the recent subprime crisis in 2008, together with the presence of strong integration of stock markets in ASEAN-5 (Indonesia, Malaysia, the Philippines, Singapore, and Thailand). Last, political risk is found to be one of the main driving forces behind the dominance of country effects.