Effects of the market factor on portfolio diversification: The case of market crashes

Cheoljun Eom; Jong Won Park; Yong H. Kim; Taisei Kaizoji

doi:10.1080/10293523.2015.994448

Effects of the market factor on portfolio diversification: The case of market crashes

Cheoljun Eom, Jong Won Park, Yong H. Kim, Taisei Kaizoji

School of Business Administration

Research output: Contribution to journal › Article › peer-review

8 Scopus citations

Abstract

This paper investigates empirically the effects of the market factor on the degree of portfolio diversification extracted from Markowitz’s mean-variance (MV) model to explore an alternative method for improving the practical usefulness of the model. It controls for various properties included in a correlation matrix of stocks in a portfolio. According to the results based on correlation matrices with and without the property of the market factor, the strength of the market factor has a negative effect on the degree of portfolio diversification in the MV model. This finding is stronger for periods of market crashes. These results suggest that the method for controlling for properties included in the correlation matrix might be a possible solution for enhancing the usefulness of the MV model from a practical perspective.

Original language	English
Pages (from-to)	71-83
Number of pages	13
Journal	Investment Analysts Journal
Volume	44
Issue number	1
DOIs	https://doi.org/10.1080/10293523.2015.994448
State	Published - 2015

Keywords

Markowitz’s mean-variance model
Portfolio diversification
Property of the market factor
Random matrix theory

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10.1080/10293523.2015.994448

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title = "Effects of the market factor on portfolio diversification: The case of market crashes",

abstract = "This paper investigates empirically the effects of the market factor on the degree of portfolio diversification extracted from Markowitz{\textquoteright}s mean-variance (MV) model to explore an alternative method for improving the practical usefulness of the model. It controls for various properties included in a correlation matrix of stocks in a portfolio. According to the results based on correlation matrices with and without the property of the market factor, the strength of the market factor has a negative effect on the degree of portfolio diversification in the MV model. This finding is stronger for periods of market crashes. These results suggest that the method for controlling for properties included in the correlation matrix might be a possible solution for enhancing the usefulness of the MV model from a practical perspective.",

keywords = "Markowitz{\textquoteright}s mean-variance model, Portfolio diversification, Property of the market factor, Random matrix theory",

author = "Cheoljun Eom and Park, {Jong Won} and Kim, {Yong H.} and Taisei Kaizoji",

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doi = "10.1080/10293523.2015.994448",

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T1 - Effects of the market factor on portfolio diversification

T2 - The case of market crashes

AU - Eom, Cheoljun

AU - Park, Jong Won

AU - Kim, Yong H.

AU - Kaizoji, Taisei

PY - 2015

Y1 - 2015

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AB - This paper investigates empirically the effects of the market factor on the degree of portfolio diversification extracted from Markowitz’s mean-variance (MV) model to explore an alternative method for improving the practical usefulness of the model. It controls for various properties included in a correlation matrix of stocks in a portfolio. According to the results based on correlation matrices with and without the property of the market factor, the strength of the market factor has a negative effect on the degree of portfolio diversification in the MV model. This finding is stronger for periods of market crashes. These results suggest that the method for controlling for properties included in the correlation matrix might be a possible solution for enhancing the usefulness of the MV model from a practical perspective.

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Effects of the market factor on portfolio diversification: The case of market crashes

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