ratio increase from .339 to .404. This approach to international diversification can be insightful because it approximates actual investor behavior. When the benefits of diversification are great, investors are motivated to reallocate assets. When the benefits are small, however, investors weigh the incremental benefits of continuing the diversification program against alternative investment opportunities. This may explain, at least partially, much of the recent interest in alternative assets such as private equity. Suppose an investor decides to move 60 percent of the way toward full diversification. Table 11.3, which pegs the corresponding portfolio weights for euro, sterling, U.S. dollar, and yen investors, shows that the proportion of total equity allocated to international equity depends on domestic equity's proportion of the global capitalization weighted portfolio: The smaller the domestic market's capitalization weight, the larger the fraction invested internationally. For example, a U.S. dollar-based investor who follows our general rule would hold 68 percent of total equity domestically (and 32 percent internationally). By contrast, a like-minded sterling-based investor would invest 45 percent of total equity domestically (and 55 percent internationally). IMPACT OF CURRENCY HEDGING ON INDIVIDUAL ASSET CLASSES Having established that the benefits of global diversification significantly decline when investors move around 60 percent of the way toward market capitalization weights in international markets, we can now turn our attention to setting currency hedging policy. We'll approach this issue in three steps: First, we'll assess the impact of currency hedging on individual asset classes. Second, we'll see what the impact of currency hedging is when all investors hold the market portfolio. Finally, we'll see what happens when investors hold our home bias-adjusted portfolios. Figure 11.3 shows how alternative hedge ratios affect portfolio volatility from four different currency perspectives. For each currency perspective, the volatility of foreign bond or foreign equity investments is plotted in relation to the level of the currency hedge. Two conclusions, irrespective of the base currency, can be drawn from the graphs in Figure 11.3. First, at any level of currency hedging, a foreign equity portfolio is more volatile than a foreign bond portfolio. Second, the currency hedge's impact on portfolio volatility is much more pronounced for foreign bond portfolios than for foreign equity portfolios. In fact, regardless of the base currency, TABLE 11.3 Home Bias-Adjusted Portfolio Weights U.S. Dollar Euro Sterling Yen Domestic equity 46.0% 34.3% 30.8% 32.3% Foreign equity 22.0 33.7 37.2 35.6 Domestic fixed income 32.0 32.0 32.0 32.0 Domestic equity/total equity 67.7 50.5 45.3 47.6