International diversification and microfinance

International commercial banks, institutional investors, and private investors have become increasingly interested in financing microfinance institutions (MFIs). This paper investigateswhether adding microfinance funds to a portfolio of risky international assets yields diversification gains. By using mean-variance spanning tests with short-sale constraints, the paper indicates that investing in microfinance may be attractive for investors seeking a better risk-return profile. More specifically, the analysis suggests that investing in MFIs from Latin America, or microfinance and rural banks may yield more efficient portfolios. In contrast, adding MFIs from Africa or microfinance NGOs to a benchmark portfolio of international assets does not seem beneficial for a mean-variance investor.

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