There are many researches with regard to the importance of country and industry effects for portfolio diversification before Phylaktis and Xia published their paper. Most of what these literatures have argued about are whether country effects or industry effects have more impact on the emerging and mature markets. On one hand, traditional studies (e.g. Lessard, 1974; Solnik, 1974; Heston and Rouwenhorst, 1994, 1995; Griffin and Karolyi, 1998) claimed that the country effects have dominated the industry effects. On the other hand, more recent researches (e.g. Baca et al. 2000, Cavaglia et al. 2000, L’Her et al. 2002, Brooks and Del Negro, 2004 and Flavin, 2004) have shown that in compare with the country effects, the industry effects are more crucial on portfolio diversification. Meanwhile, it has been suggested that in compare with the traditional diversification across countries, the international diversification across industries can provide greater risk reductions. By using different research methods, studies by Cavaglia et al. (2001) and Brooks and Del Negro (2003) both provided evidence on the connection of the dynamics of country and industry effects in firm level returns with the firm’s international activities. Unlike the paper by Cavaglia et al (2001), Brooks and Del Negro (2003)’s research did not find any remarkable statistical link between the industry factors and the extent to which firms operate internationally. All researches mentioned above focus on advanced market. However, the researches which concentrated on the sources of firms’ industry and country effects in emerging markets (e.g. Bekaert, 1995; Harvey, 1995; Bekaert and Harvey, 1995, 1997, 2000) ， Bekaert and Harvey (1997) have shown that the returns of emerging markets have significantly different characteristics from those of developed market. According to Bekaert and Harvey (1997), at least four distinguishing features of emerging market returns have been point out. Given those facts, one would expect the dynamics of country versus industry effects in emerging markets to be different from that in developed markets. Moreover, some existing papers have shown that ADR listings in aggregate foster greater integration of international capital markets. For example, according to Karolyi (2003), if ADR listings facilitate the acceleration of market integration, one would accept that domestic factors to matter less and global factors including industry ones to matter more for ADR firms. Furthermore, according to Brooks and Del Negro (2004), it is argued that the recent increase of industry effects is only confined to TMT - Technology, Media and Telecommunications – sectors and such an increase is due to IT bubbles.

The main contribution of Phylaktis and Xia (2006) is to find the reasons for the different behavior of emerging markets relative to developed markets by comparing the dynamics of emerging markets’ global, country and industry effects at the firm level. Compared to developed markets, emerging markets have higher country effects and lower global and industry effects, which explains why the global and industry effects surpass the country effects in developed markets whereas the country effects still dominate the global and industry effects in emerging markets when focusing on market level evidence. According to Phylaktis and Xia (2006), even though the dynamics of firms’ global, country and industry effects are different between emerging and developed markets, they are systematically linked to the firms’ foreign sale ratios and ADR listings. Nevertheless, the paper shows that the link between the firm’s factor effects and the TMT sectors is volatile and unstable over time.

By applying a factor model to a sample data of 1893 firms representing 37 countries within 24 industry categories from Jan 1990 to Dec 2002, the authors measure the global, country and industry effects in firm level returns. The starting point is the standard