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Effects of the market factor on portfolio diversification: the case of market crashes

Effects of the market factor on portfolio diversification: the case of market crashes This paper investigates empirically the effects of the market factor on the degree of portfolio diversification extracted from Markowitz's mean-variance (MV) model to explore an alternative method for improving the practical usefulness of the model. It controls for various properties included in a correlation matrix of stocks in a portfolio. According to the results based on correlation matrices with and without the property of the market factor, the strength of the market factor has a negative effect on the degree of portfolio diversification in the MV model. This finding is stronger for periods of market crashes. These results suggest that the method for controlling for properties included in the correlation matrix might be a possible solution for enhancing the usefulness of the MV model from a practical perspective. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Investment Analysts Journal Taylor & Francis

Effects of the market factor on portfolio diversification: the case of market crashes

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Publisher
Taylor & Francis
Copyright
© 2015 Investment Analysts Society of South Africa
ISSN
2077-0227
eISSN
1029-3523
DOI
10.1080/10293523.2015.994448
Publisher site
See Article on Publisher Site

Abstract

This paper investigates empirically the effects of the market factor on the degree of portfolio diversification extracted from Markowitz's mean-variance (MV) model to explore an alternative method for improving the practical usefulness of the model. It controls for various properties included in a correlation matrix of stocks in a portfolio. According to the results based on correlation matrices with and without the property of the market factor, the strength of the market factor has a negative effect on the degree of portfolio diversification in the MV model. This finding is stronger for periods of market crashes. These results suggest that the method for controlling for properties included in the correlation matrix might be a possible solution for enhancing the usefulness of the MV model from a practical perspective.

Journal

Investment Analysts Journal – Taylor & Francis

Published: Jan 2, 2015

Keywords: Markowitz's mean-variance model; Portfolio diversification; property of the market factor; Random matrix theory

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