39 Pages Posted: 25 May 2005 Last revised: 6 Feb 2010
Date Written: January 15, 2010
This study clears up misunderstandings regarding the diversification of unsystematic risk. Contrary to conventional wisdom, there is no evidence investors can, or have ever been able to, easily form portfolios containing negligible exposure to unsystematic returns. Because well-diversified portfolios are the bedrock upon which so much financial theory is built, investors’ inability to easily form well-diversified portfolios helps explain the persistence of anomalies and the possibility of “bubbles” in asset prices.
Keywords: limits to arbitrage, anomalies, idiosyncratic risk, market efficiency, well-diversified portfolios
JEL Classification: G00, G14
Suggested Citation: Suggested Citation