Is the Portfolio Effect Ending? Idiosyncratic and Market Risk Over the Long Run

Abstract:     
This paper revisits what we know about the risk of stocks thanks to a non-US long term database. French stock market risk observed over the last 150 years, presents a long-term rise. Despite peace and economic stability, market risk has never converged to levels seen pre-1914. Reversely, the idiosyncratic risk remains quite stable. Combining these two paths, market risk becomes the major source of total risk reducing the effect of diversification; Correlation coefficient among stocks also rises. Today, market risk explains about two thirds of the total risk whereas, before 1914, it only accounted for one half. The effect of the sequential adding stocks in one portfolio attest that, today, it is impossible to reach the level of diversification that a portfolio composed of few stocks had before 1914. At this time, a “super portfolio effect” is identified. The rise of stock market risk seems to be linked with the end of the monetary stability and the rise of public deficits over time.

Number of Pages in PDF File: 30

Keywords: volatility, diversification, idiosyncratic risk, correlation, 19th century, 20th century

JEL Classification: G1, G12, N23, N24

working papers series