| The purpose of this study is twofold. The first objective is to conduct an empirical inquiry into the diversification benefits of exchange-traded funds. The second objective is to examine whether exchange-traded funds exhibit superior performance compared to their rival closed-end country fund and traditional index mutual fund. I document that American investors manifest their preference for WEBS as a substitute for closed-end country funds. While I find that WEBS satisfy their objective of following their home indexes better than their rival closed-end country fund, the two-factor model I employ indicates that, despite some diversification benefits, WEBS also maintain certain risk exposure to the U.S. market. However, the U.S. market exposure of WEBS is marginal relative to closed-end country funds. Thus, WEBS provide American investors with a higher expected rate of return minimizing their risk exposure compared to closed-end country funds.; I find that over one, two, three, and four year periods, WEBS' performance is less dependent on the performance of the U.S. market than their rival closed-end country fund. Thus, I conclude, despite the growing interdependence of world equity markets, American investors are still able to achieve international diversification portfolio benefits by including WEBS in their asset allocation decision.; Also, I examine the performance, diversification and hedging abilities of SPDRs, MidCap SPDRs, sector specific SPDRs, DIAMONDS, and their rival traditional index fund. I document that exchange-traded funds exhibit higher tracking accuracy of their underlying index compared to traditional index mutual funds. Also, on a risk-return basis, investors would accomplish greater performance and diversification gains by employing exchange-traded funds versus traditional index mutual funds. |
