Chia, Rui Ming Daryl and Lim, Kai Jie Shawn (2012): The Attenuation of Idiosyncratic Risk under Alternative Portfolio Weighting Strategies: Recent Evidence from the UK Equity Market. Published in: International Journal of Economics and Finance , Vol. 4, No. 11 : pp. 1-14.
Download (721kB) | Preview
In this study, we investigate the attenuation of idiosyncratic risk and corresponding benefits of diversification for equally weighted and market capitalisation weighted portfolios in the UK Equity Market over 2002 - 2012. We analyse the absolute benefits of risk reduction by testing the homogeneity of variances of portfolios of different sizes using Levene's Test. Next, we perform a cost-benefit analysis to determine the return benefit of diversification from a practical perspective. We find that the absolute benefits of diversification for an equally weighted portfolio are greater in the 'crisis' than 'pre-crisis' period, but when we analyse the results from a practical perspective the benefits fall dramatically and the results are reversed. When comparing the benefits of market capitalisation weighted and equally weighted portfolios, we note that the benefits of diversification tend to be greater for an equally weighted portfolio for small portfolios but that a crossover occurs as the size of the portfolio increases. The relative benefits of diversification under these different weighting strategies are thus highly dependent upon the state of the market and further study is needed to determine why the diversification benefits for the alternative weighting strategies decay at varying rates.
|Item Type:||MPRA Paper|
|Original Title:||The Attenuation of Idiosyncratic Risk under Alternative Portfolio Weighting Strategies: Recent Evidence from the UK Equity Market|
|Keywords:||Portfolio diversification; idiosyncratic risk; index funds; weighting methodology|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions
C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C15 - Statistical Simulation Methods: General
G - Financial Economics > G0 - General > G01 - Financial Crises
|Depositing User:||Lim Kai Jie Shawn|
|Date Deposited:||24. Sep 2012 02:33|
|Last Modified:||19. Feb 2013 20:03|
Abhyankar, A., & Ho, K. Y. (2007). Long-horizon event studies and event firm portfolio weights: evidence from U.K. rights issues re-visited. International Review of Financial Analysis, 16(1), 61-80. http://dx.doi.org/10.1016/j.irfa.2005.02.001
Benjelloun, H. (2010). Evans and Archer – Forty Years Later. Investment Management and Financial Innovations, 7(1), 98-104.
Bird, R., & Tippet, M. (1986). Naive diversification and portfolio risk-A Note. Management Science, 32(2), 244-251. http://dx.doi.org/10.1287/mnsc.32.2.244
Box, G. (1953). Non-normality and tests on variances. Biometrika, 40(3), 318-335. http://dx.doi.org/10.2307/2333350
Brown, M., & Forsythe, A. (1974). Robust tests for equality of variances. Journal of the American Statistical Association, 69, 364-367. http://dx.doi.org/10.2307/2285659
Christoffersen, P., Errunza, V., Jacobs, K., & Jin, X. (2010). Is the potential for international diversification disappearing. http://dx.doi.org/10.2139/ssrn.1573345
Damodaran, A. (2010). Equity risk premiums: determinants, estimation and implications – a post-crisis update. Financial Markets, Institutions & Instruments, 18(5), 289-370.
Elton, E., & Gruber, M. (1977). Risk reduction and portfolio size: an analytical solution. Journal of Business, 50(4), 415-437. http://dx.doi.org/10.1086/295964
Evans, J., & Archer, S. (1968). Diversification and the reduction of dispersion: an empirical analysis. Journal of Finance, 23(5), 761-767. http://dx.doi.org/10.2307/2325905
Gastwirth, J., Gel, Y., & Miao, W. (2009). The impact of Levene's test of equality of variances on statistical theory and practice. Statistical Science, 24(3), 343-360. http://dx.doi.org/10.1214/09-STS301
Gupta, G.S., & Khoon, C. H. (2001). How many securities make a diversified portfolio in KLSE stocks. Asian Academy of Management Journal, 6(1), 63-79.
Hjalmarsson, E., & Manchev, P. (2012). Characteristic-based mean-variance portfolio choice. Journal of Banking & Finance, 36(5), 1392-1401.
Huang, W., Eun, C., & Lai, S. (2006). International diversification with large- and small-cap stocks. Journal of Financial and Quantitative Analysis, 43(2), 489-524. http://dx.doi.org/10.1016/j.ribaf.2011.03.003
Hwang, Y, & Min, H. (2012). Dynamic correlation analysis of US financial crisis and contagion: evidence from four OECD countries. Applied Financial Economics, 22(24), 2063-2074.
Lai, M. S., & Seiler, M. J. (2001). Is your portfolio overweighted? Know when to say when, Journal of Wealth Management, 3(4), 19-28. http://dx.doi.org/10.3905/jwm.2001.320391
Lee, S. L. (2005). The marginal benefit of diversification in commercial real estate portfolios. Working Papers in Real Estate & Planning 04/05.
Levene, H. (1960). Robust tests for equality of variances. In I. Olkin (Ed.), Contributions to Probability and Statistics (pp. 278-292). Palo Alto, California: Stanford University Press.
Lim, S., & Loh, Y. (1996). A comparison of tests of equality of variances. Computational Statistical & Data Analysis, 22(3), 287-301. http://dx.doi.org/10.1016/0167-9473(95)00054-2
Markowski, C., & Markowski, E. (1990). Conditions for the effectiveness of a preliminary test of variance. The American Statistician, 44(4), 322-326. http://dx.doi.org/10.2307/2684360
Mukherji, S. (2011). The capital asset pricing model’s risk-free rate. The International Journal of Business and Finance Research, 5(2), 75-83.
Newbould, G. D., & Poon, P. S. (1993). Portfolio risk, portfolio performance, and the individual investor, Journal of Investing, 5(2), 72-78. http://dx.doi.org/10.3905/joi.5.2.72
Newbould, G. D., & Poon, P. S. (1993). The minimum number of stocks needed for diversification. Financial Practice and Education 3, 85–87.
Snedecor, G. W., & Cochran, W. G. (1976). Statistical Methods (6th ed.). Ames, IA: Iowa State University Press. http://dx.doi.org/10.1097/00010694-195702000-00023
Statman, M. (1987). How many stocks make a diversified portfolio. Journal of Financial and Quantitative Analysis, 22(3), 353-363. http://dx.doi.org/10.2307/2330969
Statman, M. (2004). The diversification puzzle, Financial Analysts Journal, 60(4), 44-53. http://dx.doi.org/10.2469/faj.v60.n4.2636