Limited Diversification, Portfolio Inertia, and Ambiguous Correlation

56 Pages Posted: 21 May 2020

See all articles by Julia Jiang

Julia Jiang

affiliation not provided to SSRN

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management

Weidong Tian

University of North Carolina (UNC) at Charlotte - The Belk College of Business Administration

Xudong Zeng

Shanghai University of Finance and Economics, School of Finance

Date Written: April 25, 2020

Abstract

We study the effects of correlation ambiguity on portfolio choice in a market with multiple risky assets. We find that the optimal portfolio contains only a fraction of risky assets under correlation ambiguity, and in particular, just one risky asset enters the optimal portfolio if the level of correlation ambiguity is substantial. We demonstrate that the optimal portfolio does not change when assets’ Sharpe ratios change within a range. Our ambiguity-aversion model on correlation explains both the limited diversification property and the portfolio inertia property in household portfolios and retirement accounts. We further provide simulation evidences of the limited diversification and portfolio inertia feature of the optimal portfolio by a broad set of stocks. This paper suggests that correlation ambiguity has important implications for portfolio choice.

Keywords: Correlation ambiguity, portfolio choice, limited diversification, portfolio inertia

JEL Classification: G11

Suggested Citation

Jiang, Julia and Liu, Jun and Tian, Weidong and Zeng, Xudong, Limited Diversification, Portfolio Inertia, and Ambiguous Correlation (April 25, 2020). Available at SSRN: https://ssrn.com/abstract=3584888 or http://dx.doi.org/10.2139/ssrn.3584888

Julia Jiang

affiliation not provided to SSRN

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858.534.2022 (Phone)
5858.534.0745 (Fax)

Weidong Tian

University of North Carolina (UNC) at Charlotte - The Belk College of Business Administration ( email )

9201 University City Boulevard
Charlotte, NC 28223-0001
United States

HOME PAGE: http://belkcollegeofbusiness.uncc.edu/wtian1/

Xudong Zeng (Contact Author)

Shanghai University of Finance and Economics, School of Finance ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
55
Abstract Views
379
rank
455,338
PlumX Metrics