What Measures the Benefits of Diversification

19 Pages Posted: 11 Aug 2005

See all articles by Meir Statman

Meir Statman

Santa Clara University - Department of Finance

Jonathan Scheid

Loring Ward Advisor Services

Date Written: May 2005

Abstract

While correlation is the common indicator of the benefits of diversification, it is not a good indicator. This is for three reasons. First, diversifiable risk depends not only on the correlations between stock returns but also on the standard deviations of stock returns. Second, correlation does not provide an intuitive indicator of the benefits of diversification. Third, expected diversifiable risk, estimated from correlations and standard deviations, is biased when the distribution of the returns of stocks around the mean return of all stocks is not normal. We know diversifiable risk as unsystematic risk, tracking error and dispersion. We analyze diversifiable risk in portfolios of U.S. stocks during 1980-2004.

Keywords: Diversification, correlations, dispersion, tracking errors, portfolio theory

JEL Classification: G11, G14

Suggested Citation

Statman, Meir and Scheid, Jonathan, What Measures the Benefits of Diversification (May 2005). Available at SSRN: https://ssrn.com/abstract=774348 or http://dx.doi.org/10.2139/ssrn.774348

Meir Statman (Contact Author)

Santa Clara University - Department of Finance ( email )

500 El Camino Real
Santa Clara, CA 95053
United States
408-554-4147 (Phone)
408-554-4029 (Fax)

Jonathan Scheid

Loring Ward Advisor Services ( email )

3055 Olin Ave., Suite 2000
San Jose, CA 95128
United States

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