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How to quantify the influence of correlations on investment diversification

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  • Matus Medo
  • Chi Ho Yeung
  • Yi-Cheng Zhang

Abstract

When assets are correlated, benefits of investment diversification are reduced. To measure the influence of correlations on investment performance, a new quantity - the effective portfolio size - is proposed and investigated in both artificial and real situations. We show that in most cases, the effective portfolio size is much smaller than the actual number of assets in the portfolio and that it lowers even further during financial crises.

Suggested Citation

  • Matus Medo & Chi Ho Yeung & Yi-Cheng Zhang, 2008. "How to quantify the influence of correlations on investment diversification," Papers 0805.3397, arXiv.org, revised Feb 2009.
  • Handle: RePEc:arx:papers:0805.3397
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    File URL: http://arxiv.org/pdf/0805.3397
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    References listed on IDEAS

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    11. Medo, Matúš & Pis’mak, Yury M. & Zhang, Yi-Cheng, 2008. "Diversification and limited information in the Kelly game," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(24), pages 6151-6158.
    12. Matus Medo & Yury M. Pis'mak & Yi-Cheng Zhang, 2008. "Diversification and limited information in the Kelly game," Papers 0803.1364, arXiv.org, revised Jul 2008.
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    Cited by:

    1. Charfeddine, Lanouar & Najah, Ahlem & Teulon, Frédéric, 2016. "Socially responsible investing and Islamic funds: New perspectives for portfolio allocation," Research in International Business and Finance, Elsevier, vol. 36(C), pages 351-361.
    2. Stéphanie Prat & Sophie Brana, 2010. "The Introduction of Emerging Currencies into a Portfolio: Towards a more Complete Diversification Model," International Economics, CEPII research center, issue 121, pages 5-24.

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