Explaining Diversification With Gain and Loss

29 Pages Posted: 23 Apr 2002  

Michael S. Rozeff

SUNY at Buffalo - Department of Financial & Managerial Economics

Philip F. O'Connor

University of Auckland - Department of Accounting and Finance; University of Waikato - Management School

Date Written: April 2002

Abstract

This paper shows how to explain diversification using gain and loss. The gain-loss approach focuses on the cancellation of returns that occurs as stocks enter a portfolio. Simple algebra and arithmetic explain exactly how diversification acts to raise a portfolio's gain-loss ratio. The method requires no knowledge or use of variance or covariance. In addition, the paper shows how gain and loss are consistent with the capital asset pricing model (CAPM) and interprets the gain-loss reward-risk concepts of co-gain and co-loss in a CAPM context.
teaching, CAPM

Keywords: gain-loss, gain, loss, diversification, portfolio,

JEL Classification: A20, G10, G11

Suggested Citation

Rozeff, Michael S. and O'Connor, Philip F., Explaining Diversification With Gain and Loss (April 2002). Available at SSRN: https://ssrn.com/abstract=308325 or http://dx.doi.org/10.2139/ssrn.308325

Michael S. Rozeff

SUNY at Buffalo - Department of Financial & Managerial Economics ( email )

Buffalo, NY 14260
United States

Philip F. O'Connor (Contact Author)

University of Auckland - Department of Accounting and Finance ( email )

Private Bag 92019
Auckland 1001
New Zealand
+649-923-9431 (Phone)

University of Waikato - Management School ( email )

Hamilton
New Zealand
+64 7 838 4466 (Phone)

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