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How many independent bets are there?

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  • Daniel Polakow

    (University of Cape Town)

  • Tim Gebbie

Abstract

The benefits of portfolio diversification are a central tenet implicit in modern financial theory and practice. Linked to diversification is the notion of breadth. Breadth is correctly thought of as the number of independent bets available to an investor. Conventionally, applications using breadth frequently assume only the number of separate bets. There may be a large discrepancy between these two interpretations. We utilise a simple singular-value decomposition and the Kaiser–Guttman stopping criterion to select the integer-valued effective dimensionality of the correlation matrix of returns. In an emerging market such as South Africa, we document an estimated breadth that is considerably lower than anticipated. This lack of diversification may be because of market concentration, exposure to the global commodity cycle and local currency volatility. We discuss some practical extensions to a more statistically correct interpretation of market breadth and its theoretical implications for both global and domestic investors.

Suggested Citation

  • Daniel Polakow & Tim Gebbie, 2008. "How many independent bets are there?," Journal of Asset Management, Palgrave Macmillan, vol. 9(4), pages 278-288, October.
    • Handle: RePEc:pal:assmgt:v:9:y:2008:i:4:d:10.1057_jam.2008.26
    DOI: 10.1057/jam.2008.26
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    References listed on IDEAS

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    1. Louis Guttman, 1954. "Some necessary conditions for common-factor analysis," Psychometrika, Springer;The Psychometric Society, vol. 19(2), pages 149-161, June.
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    Cited by:

    1. Jem Tugwell, 2011. "Skill or luck? The role of strategies and scenario analysis as a competitive differentiator for fund management firms," Journal of Asset Management, Palgrave Macmillan, vol. 12(4), pages 281-291, September.

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