1. When constructing stock portfolios, what negative side effects can result from ignoring country membership?
  2. What are the two types of country bets that may arise in stock portfolios and what are the drawbacks of each?
  3. Why do “country noise” bets arise and why is it impossible to avoid them without directly considering country membership?
  4. How do these issues differ between developed and emerging markets?
  5. What approach do we recommend for avoiding unintended country bets in stock portfolios?

* We thank Michael Katz, John Liew, Lasse Pedersen, and Prasad Ramanan for helpful comments. The views and opinions expressed herein are those of the authors and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates, or its employees.

1 See Jianguo Chen, Ting Zheng, and Andrea Bennett, “Sector Effects in Developed vs. Emerging Markets,” Financial Analysts Journal 62, no. 6 (2006): 40–51; Steven L. Heston and K. Geert Rouwenhorst, “Industry and Country Effects in International Stock Returns,” Journal of Portfolio Management 21, no. 3 (1995): 53–58; Kate Phylaktis and Lichuan Xia, “Sources of Firms' Industry and Country Effects in Emerging Markets,” Journal of International Money and Finance 25, no. 3 (2006): 459–475; Ana Paula Serra, “Country and Industry Factors in Returns: Evidence from Emerging Markets' Stocks,” Emerging Markets Review 1, no. 1 (2000): 127–151; Frank Nielsen, “Emerging Markets: A 2009 Update,” MSCI Barra webinar, August 13, 2009; and ...

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