Equity Portfolio Diversification: How Many Stocks are Enough? Evidence from Five Developed Markets

Abstract

Choosing the number of stocks to hold in a portfolio can significantly affect its risk. We use daily observations for traded equity returns in the US, UK, Japan, Canada and Australia from 1975 to 2011 to simulate portfolios and calculate several measures of risk, including heavy tailed. For each measure, we estimate confidence bands to assure a specific reduction in diversifiable risk. The optimal number of stocks is shown to depend on the measure of risk, level of assurance required by investors, the specific stock market, and the changing correlation structure across time.

Keywords: portfolio diversification, international investing, heavy tailed risk, expected shortfall, time series standard deviation, terminal wealth standard deviation

JEL Classification: G11, C15