We investigate the diversification benefits and optimal portfolio allocation across different US asset classes. Our
results from applying the principal component analysis (PCA) show that although there is an increasing trend in
market integration, five major financial markets (equities, bonds, currencies, commodities, and real estate) appear to
be weakly and at most moderately integrated. Applying the mean-variance portfolio simulations and out-of-sample
analysis to evaluate the benefits of diversification, we find that adding new asset classes such as oil, precious metals,
currency, and real estate into a traditional portfolio of stocks and bonds significantly improves its risk-adjusted
performance. Diversification benefit is low during contagion periods defined as a period when correlation of
residuals from PC regression is significantly different from zero. Nonetheless, an additional gain from
diversification is greater during contagion periods than normal periods. Bonds provide the best hedge during
contagion periods whereas stocks perform the best during normal periods.