Effects of the market factor on portfolio diversification: the case of market crashes

This paper investigates empirically the effects of the market factor on the degree of portfolio diversification extracted from Markowitz's mean-variance (MV) model to explore an alternative method for improving the practical usefulness of the model. It controls for various properties included i...

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Bibliographic Details
Published in:The investment analysts journal 2015-01, Vol.44 (1), p.71-83
Main Authors: Eom, Cheoljun, Park, Jong Won, Kim, Yong H., Kaizoji, Taisei
Format: Article
Language:English
Subjects:
Markowitz's mean-variance model
Portfolio diversification
Property of the market factor
Random matrix theory
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Summary:This paper investigates empirically the effects of the market factor on the degree of portfolio diversification extracted from Markowitz's mean-variance (MV) model to explore an alternative method for improving the practical usefulness of the model. It controls for various properties included in a correlation matrix of stocks in a portfolio. According to the results based on correlation matrices with and without the property of the market factor, the strength of the market factor has a negative effect on the degree of portfolio diversification in the MV model. This finding is stronger for periods of market crashes. These results suggest that the method for controlling for properties included in the correlation matrix might be a possible solution for enhancing the usefulness of the MV model from a practical perspective.
ISSN:1029-3523
2077-0227
DOI:10.1080/10293523.2015.994448