EFF/KRF: Inflation does not have much volatility over short-term periods, for example, two years or less, so for short-term bonds there is little benefit from international diversification to lower inflation risks. For intermediate and long-term portfolios, international diversification to lower inflation risk makes sense if the portfolio is hedged against short-term changes in exchange rates. The hedge is helpful because purchasing power parity does not hold; that is, exchange rates vary more than can be explained by changes in the price levels in countries. With purchasing power parity, hedging the exchange rate would be unnecessary.
Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.