Country versus Sector Diversification after the Introduction of the EMU

The introduction of the European monetary union (EMU) led to a convergence of the participating countries in many ways. One particular aspect is the diversification potential among different financial markets. While during the 1990s country effects typically dominated industry effects in magnitude, more recent studies stress the importance of industry diversification when it comes to portfolio construction. We show the increasing correlations among countries' equity market returns and the contemporaneous decrease in sector correlations and confirm the growing importance of industry effects by applying a bootstrapping method.
Supported by this finding we implement momentum strategies based on countries and industries, respectively, in order to compare their performance. Due to the better diversification potential, most of the sector models outperform the country frameworks on a risk adjusted basis