diversification. When using country indexes to determine the relative importance of country effects, it is important to note that country indexes differ in terms of sector composition. For example, relative to Switzerland, the Swedish index contains more firms in basic industries while Switzerland has more banks. So, each country really is a sector and correlations between sectors are low. 3.    Country-specific economic shocks. Important economic shocks that affect firms differ across countries. This may be because the shocks are regional in nature, such as a change in fiscal or monetary policy that is specific to a country. Alternatively, it may be because national markets behave differently from global shocks. Either way, economic shocks can cause variation in stock returns that is country specific. In sum, the occurrence of shocks that affect banks in Switzerland differently from banks in Sweden is more important for explaining the low correlation between their country returns than the fact that Sweden has fewer banks. More recent research has emphasized the increasing importance of industry factors for explaining risk relative to country factors. Most notable among this research have been publications by Aked, Brightman, and Cavaglia (2000); Munro and Jelicic (2000); and Rouwenhorst (1998a). The general conclusion from this research is that diversification across industries now provides greater risk reduction benefits than diversification across countries. Intuitively, arguments supporting an increasing role for industry factors in explaining risk fall along two lines: 1.    Decline in trade barriers-for example, the General Agreement on Tariffs and Trade (GATT) and the North America Free Trade Agreement (NAFTA)-and economic policy coordination-for example, the Economic and Monetary Union (EMU). 2.    Increasing globalization of firms' revenues and operations and the increasing proportion of intra-industry mergers and acquisitions. When it comes to quantifying the relative importance of industry and country effects in explaining the variation of security returns, published research has been less than conclusive. We identify four reasons for this inconclusiveness: 1.    Geographical scope of study (Europe vs. global; developed vs. undeveloped). Results vary with the choice of countries analyzed. 2.    Industry classification (broad sectors vs. finer industries). Results can vary with the type of industry classifications scheme (e.g., Dow Jones STOXX vs. MSCI). 3.    Historical period analyzed. 4.    Definition of security exposure to a country. For example, some researchers define a security's exposure to a particular country in terms of a 0/1 indicator variable. Others assume that the security's beta is its country exposure. Results can clearly depend on the choice of exposure, and both definitions have their advantages and disadvantages.