Investing globally expands an investor’s opportunity set beyond domestic markets. Because different national economies operate on distinct business cycles and monetary policies, international equity correlations are typically lower than domestic-only pairings. This shift pushes the portfolio’s efficient frontier outward, reducing overall volatility.

When an investor buys an international asset, their total return in their domestic currency (\(R_{d}\)) depends on both the asset’s local return (\(R_{l}\)) and the percentage change in the foreign currency’s value
R_fx:

1 + R_d = (1 + R_l)(1 + R_fx)

R_d = R_l + R_fx + (R_l × R_fx)

Where a positive \(R_{fx}\) means the foreign currency appreciated against the investor’s home currency.

The total variance of this international investment is driven by asset risk, currency risk, and their interaction:

σd^2 ≈ σ_l^2 + σ_fx^2 + 2 σ_l σ_fx ρ{l,fx}

Portfolio managers must decide whether to accept currency volatility or hedge it out using derivatives: