A note on diversification and the reduction of dispersion

Johnson, Keith H.; Shannon, Donald S.

doi:10.1016/0304-405x(74)90015-4

Cited by 43 publications

(16 citation statements)

References 4 publications

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“…In this respect, similar to Evans and Archer (1968);Statman (1987); Elton and Gruber (1977); Johnson and Shannon (1974); Bird and Tippett (1986), we measure how the benefit of diversification vary as the number of external assets in an equally weighted portfolio is increased. This benchmark is the so-called 1/n or naive rule.…”

Section: Related Workmentioning

confidence: 99%

“…Similar to Evans and Archer (1968);Statman (1987); Elton and Gruber (1977); Johnson and Shannon (1974); Bird and Tippett (1986), in this section we measure the advantage of diversification by determining the rate at which risk reduction benefits are realized as the number m (≤ M ) of external assets in an equally weighted portfolio is increased. In contrast with those studies, rather than minimizing the variance of the banks' assets, we maximize their expected utility with respect to m. The methodology is explained in the following subsections.…”

Section: Benefits Of Diversification In External Assetsmentioning

confidence: 99%

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Diversification and Financial Stability

Tasca¹,

Battiston

2011

SSRN Journal

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This paper contributes to a growing literature on the pitfalls of diversification by shedding light on a new mechanism under which, full risk diversification can be suboptimal. In particular, banks must choose the optimal level of diversification in a market where returns display a bimodal distribution. This feature results from the combination of two opposite economic trends that are weighted by the probability of being either in a bad or in a good state of the world. Banks have also interlocked balance sheets, with interbank claims marked-to-market according to the individual default probability of the obligor. Default is determined by extending the Black and Cox (1976) first-passagetime approach to a network context. We find that, even in the absence of transaction costs, the optimal level of risk diversification is interior. Moreover, in the presence of market externalities, individual incentives favor a banking system that is overdiversified with respect to the level of socially desirable diversification. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means without the prior permission in writing of the publisher nor be issued to the public or circulated in any form other than that in which it is published. AbstractThis paper contributes to a growing literature on the pitfalls of diversification by shedding light on a new mechanism under which, full risk diversification can be sub-optimal. In particular, banks must choose the optimal level of diversification in a market where returns display a bimodal distribution. This feature results from the combination of two opposite economic trends that are weighted by the probability of being either in a bad or in a good state of the world. Banks have also interlocked balance sheets, with interbank claims marked-to-market according to the individual default probability of the obligor. Default is determined by extending the Black and Cox (1976) first-passage-time approach to a network context. We find that, even in the absence of transaction costs, the optimal level of risk diversification is interior. Moreover, in the presence of market externalities, individual incentives favor a banking system that is over-diversified with respect to the level of socially desirable diversification.

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Section: Related Workmentioning

confidence: 99%

Section: Benefits Of Diversification In External Assetsmentioning

confidence: 99%

Diversification and Financial Stability

Tasca¹,

Battiston

2011

SSRN Journal

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“…Whether this is due to skill or luck is hard to tell. According to Jacob (1974), Johnson and Shannon (1974) and others, an investor can reduce unsystematic risk significantly with only a few securities if he or she chooses stocks sensibly. Per contrast, Goetzmann and…”

Section: Judicious Portfolio Selectionmentioning

confidence: 99%

The Downside Risk of Heavy Tails Induces Low Diversification

Hyung

Vries

2010

SSRN Journal

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Actual portfolios contain fewer stocks than are implied by standard financial analysis that balances the costs of diversification against the benefits in terms of the standard deviation of the returns. Suppose a safety first investor cares about downside risk and recognizes the heavy tail feature of the asset return distributions. Then we show that optimal portfolio sizes are smaller than traditional correlation based diversification analysis suggests. * We would like to thank Jay M. Chung for introducing us to the paper by Statman (1987).

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“…See, for example, Jones Lang Wootton (1986), Barber (1991), Cullen (1991), Myer et al (1997) and Byrne and Lee (2000) for studies in the property market, and Evans and Archer (1968), Wagner and Lau (1971), Johnson and Shannon (1974), Tole (1982) and Lloyd et al (1981) for studies in equity and bond markets.…”

Section: Notesmentioning

confidence: 98%

Risk reduction and real estate portfolio size

Byrne

2001

Manage Decis Econ

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There is remarkably little empirical evidence of the advantages of increased size on risk levels in real estate portfolios based on actual portfolios. This paper improves this by examining the portfolio risk of a large sample of actual real estate data in the UK over the period from 1981 to 1996. The results show that real estate portfolios of larger sizes tend, on average, to have lower risks than smaller sized portfolios and, more importantly, that portfolios with only a few assets can have very high or very low risk. For fund managers to be confident that their portfolio will have a risk level like the average, they need to hold portfolios of a considerably greater size than they might expect, or can sensibly acquire. Previous studies suggesting that only 20-40 properties are needed to reduce the risk of a property portfolio down to the market level are a significant underestimate. The actual figure is likely to be 400-500 properties, well above that of even the largest fund in the UK. Size alone does not necessarily lead to a reduction in portfolio risk. Other factors are of greater importance. Copyright © 2001 John Wiley & Sons, Ltd.

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A note on diversification and the reduction of dispersion

Cited by 43 publications

References 4 publications

Diversification and Financial Stability

Diversification and Financial Stability

The Downside Risk of Heavy Tails Induces Low Diversification

Risk reduction and real estate portfolio size

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