The effects of monetary policy on stock markets: cross-country evidence

This paper investigates the geographical distribution of British and German capital investments made abroad during the first global finance period 1870-1913. Given the markedly different patterns of foreign investments (with Germany allocating the largest share of their investments in European securities and with British investors preferring to invest in the New World countries and the Empire), it is relevant to ask if the German or the British foreign allocations across different geographic regions were optimal from the point of view of a rational investor. By employing modern portfolio theory, and making use of a new monthly database of bonds traded on the London and Berlin markets, this paper takes into account returns, risks and diversification opportunities of securities, making it possible to point out the structure of the optimal portfolio, i.e. how an investor should allocate his wealth among different regions. To determine which market allocated closest to the recommendations obtained from this portfolio analysis the optimal portfolio is computed which is then compared with estimates of actual British and German portfolios.

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