IDEAS home Printed from https://ideas.repec.org/a/mve/journl/v38y2012i1p23-42.html

The Opportunity Cost of Holding a “Naive” Portfolio

Author

Listed:
  • Alice A. Melkumian

    (Western Illinois University)

Abstract

The paper explores the effect of “naive” portfolio strategies on investors’ welfare. A “naive” portfolio as a sub-optimal investment strategy produces sub-optimal asset allocations that result in investors’ welfare losses. To measure those losses I compare sub-optimal portfolios with optimal portfolios using the proportionate opportunity cost with various CRRA utility functions. A vector autoregression is used to generate the joint distribution of asset returns. I show that the opportunity cost of investing in “naive” portfolios does not exceed 16.7% while investing in the optimal number of asset and does not exceed 20.4% while investing in a sub-optimal number of assets.

Suggested Citation

  • Alice A. Melkumian, 2012. "The Opportunity Cost of Holding a “Naive” Portfolio," Journal of Economic Insight, Missouri Valley Economic Association, vol. 38(1), pages 23-42.
    • Handle: RePEc:mve:journl:v:38:y:2012:i:1:p:23-42
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a
    for a similarly titled item that would be available.

    References listed on IDEAS

    as
    1. Ravi Jagannathan & Narayana R. Kocherlakota, 1996. "Why should older people invest less in stock than younger people?," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 20(Sum), pages 11-23.
    2. Ping Cheng & Youguo Liang, 2000. "Optimal Diversification: Is It Really Worthwhile?," Journal of Real Estate Portfolio Management, Taylor & Francis Journals, vol. 6(1), pages 7-16, January.
    3. Bertaut, Carol C. & Haliassos, Michael, 1997. "Precautionary portfolio behavior from a life-cycle perspective," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1511-1542, June.
    4. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1996. "Income Risk, Borrowing Constraints, and Portfolio Choice," American Economic Review, American Economic Association, vol. 86(1), pages 158-172, March.
    5. Arthur B. Kennickell & Martha Starr-McCluer & Brian J. Surette, 2000. "Recent Changes in U.S. Family Finances: Results from the 1998 Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), vol. 86(1), pages .1-29, January.
    6. Carol C. Bertaut, 1998. "Stockholding Behavior Of U.S. Households: Evidence From The 1983-1989 Survey Of Consumer Finances," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 263-275, May.
    7. Jianakoplos, Nancy Ammon & Bernasek, Alexandra, 1998. "Are Women More Risk Averse?," Economic Inquiry, Western Economic Association International, vol. 36(4), pages 620-630, October.
    8. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2010. "1/N and long run optimal portfolios: results for mixed asset menus," Working Papers 2010-003, Federal Reserve Bank of St. Louis.
    9. Yusif Simaan, 1993. "What is the Opportunity Cost of Mean-Variance Investment Strategies?," Management Science, INFORMS, vol. 39(5), pages 578-587, May.
    10. Orazio P. Attanasio & Hilary Williamson Hoynes, 2000. "Differential Mortality and Wealth Accumulation," Journal of Human Resources, University of Wisconsin Press, vol. 35(1), pages 1-29.
    11. Kathleen Arano & Carl Parker & Rory Terry, 2010. "Gender‐Based Risk Aversion And Retirement Asset Allocation," Economic Inquiry, Western Economic Association International, vol. 48(1), pages 147-155, January.
    12. Kroll, Yoram & Levy, Haim & Markowitz, Harry M, 1984. "Mean-Variance versus Direct Utility Maximization," Journal of Finance, American Finance Association, vol. 39(1), pages 47-61, March.
    13. Sankaran, Jayaram K. & Patil, Ajay A., 1999. "On the optimal selection of portfolios under limited diversification," Journal of Banking & Finance, Elsevier, vol. 23(11), pages 1655-1666, November.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Alla A. Melkumian, 2006. "The opportunity cost of being constrained by the type of assets: Bonds only or stocks only," Journal of Applied Economics, Universidad del CEMA, vol. 9, pages 325-343, November.
    2. Alice Melkumian, 2010. "The cost of a short-selling constraint - welfare implications for investors under uncertainty," Applied Economics Letters, Taylor & Francis Journals, vol. 17(9), pages 849-860.
    3. Börsch-Supan, Axel & Eymann, Angelika, 2000. "Household portfolios in Germany," Papers 00-15, Sonderforschungsbreich 504.
    4. Mostafa Saidur Rahim Khan & Naheed Rabbani & Yoshihiko Kadoya, 2020. "Is Financial Literacy Associated with Investment in Financial Markets in the United States?," Sustainability, MDPI, vol. 12(18), pages 1-14, September.
    5. Tami Gurley-Calvez & Josephine Lugovskyy, 2019. "The role of entrepreneurial risk in financial portfolio allocation," Small Business Economics, Springer, vol. 53(4), pages 839-858, December.
    6. Tansel Yilmazer & Stephen Lich, 2015. "Portfolio choice and risk attitudes: a household bargaining approach," Review of Economics of the Household, Springer, vol. 13(2), pages 219-241, June.
    7. Li, Mingzhe, 2025. "A Theory of Portfolio Choice for Heterogeneous Investors," MPRA Paper 126642, University Library of Munich, Germany, revised 29 Oct 2025.
    8. Kaustia, Markku & Conlin, Andrew & Luotonen, Niilo, 2023. "What drives stock market participation? The role of institutional, traditional, and behavioral factors," Journal of Banking & Finance, Elsevier, vol. 148(C).
    9. Börsch-Supan, Axel & Eymann, Angelika, 2000. "Household Portfolios in Germany," Discussion Papers 603, Institut fuer Volkswirtschaftslehre und Statistik, Abteilung fuer Volkswirtschaftslehre.
    10. Markowitz, Harry, 2014. "Mean–variance approximations to expected utility," European Journal of Operational Research, Elsevier, vol. 234(2), pages 346-355.
    11. Fabio C. Bagliano & Carolina Fugazza & Giovanna Nicodano, 2014. "Optimal Life-Cycle Portfolios for Heterogeneous Workers," Review of Finance, European Finance Association, vol. 18(6), pages 2283-2323.
    12. Vicki L. Bogan & David R. Just & Brian Wansink, 2013. "Do Psychological Shocks Affect Financial Risk Taking Behavior? A Study Of U.S. Veterans," Contemporary Economic Policy, Western Economic Association International, vol. 31(3), pages 457-467, July.
    13. Joseph R. Blasi & Douglas L. Kruse & Harry M. Markowitz, 2010. "Risk and Lack of Diversification under Employee Ownership and Shared Capitalism," NBER Chapters, in: Shared Capitalism at Work: Employee Ownership, Profit and Gain Sharing, and Broad-based Stock Options, pages 105-136, National Bureau of Economic Research, Inc.
    14. Charlotte Christiansen & Juanna Schröter Joensen & Jesper Rangvid, 2015. "Understanding The Effects Of Marriage And Divorce On Financial Investments: The Role Of Background Risk Sharing," Economic Inquiry, Western Economic Association International, vol. 53(1), pages 431-447, January.
    15. Simaan, Majeed & Simaan, Yusif & Tang, Yi, 2018. "Estimation error in mean returns and the mean-variance efficient frontier," International Review of Economics & Finance, Elsevier, vol. 56(C), pages 109-124.
    16. Michael W. Brandt & Amit Goyal & Pedro Santa-Clara & Jonathan R. Stroud, 2005. "A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return Predictability," The Review of Financial Studies, Society for Financial Studies, vol. 18(3), pages 831-873.
    17. Alessandra Carleo & Francesco Cesarone & Andrea Gheno & Jacopo Maria Ricci, 2017. "Approximating exact expected utility via portfolio efficient frontiers," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 40(1), pages 115-143, November.
    18. Raffaele Miniaci & Sergio Pastorello, 2010. "Mean-variance econometric analysis of household portfolios," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(3), pages 481-504.
    19. Claudia Curi & Andreas Dibiasi & Matteo Ploner & Mirco Tonin, 2026. "Gender Differences in Pension Investment: The Role of Biased Advice," CESifo Working Paper Series 12569, CESifo.
    20. Vicki L. Bogan & Angela R. Fertig, 2013. "Portfolio Choice and Mental Health," Review of Finance, European Finance Association, vol. 17(3), pages 955-992.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:mve:journl:v:38:y:2012:i:1:p:23-42. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Cullen Goenner (email available below). General contact details of provider: https://edirc.repec.org/data/mveaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.