43 Pages Posted: 20 Nov 2015 Last revised: 29 Jun 2017
Date Written: June 27, 2017
We show that correlation ambiguity has significant effects on portfolio choice. The optimal portfolio can contain only one risky asset (anti-diversification). More generally, the optimal portfolio contains only a subset of available risky assets. With 100 available stocks randomly selected from the S&P 500, the optimal portfolio contains less than 20 stocks on average. Thus, correlation ambiguity provides an explanation for under-diversification documented in empirical studies. Even though the optimal portfolio under correlation ambiguity is less diversified than the standard mean-variance portfolio, it is less risky in the sense that it has smaller variance and fewer extremely large positions.
Keywords: potfolio choice, under-diversification, ambiguity, correlation
JEL Classification: G11
Suggested Citation: Suggested Citation