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Diversification in Portfolios of Individual Stocks: 100 Stocks Are Not Enough

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  • Dale L. Domian
  • David A. Louton
  • Marie D. Racine
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    Abstract

    We examine returns and ending wealth in portfolios selected from 1,000 large U.S. stocks over a 20-year holding period. Shortfall risk, the possibility of ending wealth being below a target, is a useful metric for long horizon investors and is consistent with the Safety First criterion. Density functions obtained from simulations illustrate that shortfall risk reduction continues as portfolio size is increased, even above 100 stocks. A slightly lower risk can be achieved in small portfolios by diversifying across industries, but a greater reduction is obtained by simply increasing the number of stocks. Copyright 2007, The Eastern Finance Association.

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    Bibliographic Info

    Article provided by Eastern Finance Association in its journal Financial Review.

    Volume (Year): 42 (2007)
    Issue (Month): 4 (November)
    Pages: 557-570

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    Handle: RePEc:bla:finrev:v:42:y:2007:i:4:p:557-570

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    Web page: http://www.easternfinance.org/
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    Web: http://www.blackwellpublishing.com/subs.asp?ref=0732-8516

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    Cited by:
    1. Tienyu Hwang & Simon Gao & Heather Owen, 2012. "A two-pass model study of the CAPM: evidence from the UK stock market," Studies in Economics and Finance, Emerald Group Publishing, vol. 29(2), pages 89-104, June.
    2. Alexeev, Vitali & Dungey, Mardi, 2013. "Equity portfolio diversification with high frequency data," Working Papers 2013-18, University of Tasmania, School of Economics and Finance, revised 01 Nov 2013.
    3. Hyung, Namwon & de Vries, Casper G., 2012. "Simulating and calibrating diversification against black swans," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1162-1175.
    4. Namwon Hyung & Casper G. de Vries, 2010. "The Downside Risk of Heavy Tails induces Low Diversification," Tinbergen Institute Discussion Papers 10-082/2, Tinbergen Institute.
    5. Yunker, James A. & Melkumian, Alla A., 2010. "The effect of capital wealth on optimal diversification: Evidence from the Survey of Consumer Finances," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(1), pages 90-98, February.
    6. Li, Zhongfei & Yao, Jing & Li, Duan, 2010. "Behavior patterns of investment strategies under Roy's safety-first principle," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(2), pages 167-179, May.

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