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Market conditions and the effect of diversification on mutual fund performance: should funds be more concentrative under crisis?

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  • Jin-Li Hu

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  • Tzu-Pu Chang
  • Ray Chou

Abstract

This paper investigates the non-monotonic and non-linear effect of diversification on mutual fund performance. We apply a frontier-based efficiency measure, the stochastic frontier approach, to estimate fund efficiency and the benefit of diversification. The empirical results indicate that concentration strategy may not be appropriate for fund managers, and the benefit of diversification disappears or negatively affects performance when a fund holds too large a number of different stocks. Moreover, this paper examines whether market conditions moderate the relation between diversification and fund performance. The result shows that the benefit of diversification increases within low market return, high market volatility, and financial crisis, implying that the number of stocks needed to achieve a well-diversified portfolio increases under such market conditions. Copyright Springer Science+Business Media New York 2014

Suggested Citation

  • Jin-Li Hu & Tzu-Pu Chang & Ray Chou, 2014. "Market conditions and the effect of diversification on mutual fund performance: should funds be more concentrative under crisis?," Journal of Productivity Analysis, Springer, vol. 41(1), pages 141-151, February.
  • Handle: RePEc:kap:jproda:v:41:y:2014:i:1:p:141-151
    DOI: 10.1007/s11123-012-0331-x
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    References listed on IDEAS

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    More about this item

    Keywords

    Diversification; Market conditions; Mutual funds; Non-monotonic effect; Stochastic frontier; Crisis; C30; G11;

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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