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Experimental Evidence on Portfolio Size and Diversification: Human Biases in Naïve Security Selection and Portfolio Construction
Author(s) -
Chance Don M.,
Shynkevich Andrei,
Yang TungHsiao
Publication year - 2011
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.2011.00307.x
Subject(s) - diversification (marketing strategy) , portfolio , selection (genetic algorithm) , econometrics , financial economics , business , economics , actuarial science , computer science , marketing , artificial intelligence
We conduct an experiment in which individuals select securities to reproduce the well‐known relationship between portfolio risk and the number of securities. The standard result occurs on average but not for most individuals, many of whom effectively de‐diversify as they add seemingly random securities. Moreover, only slightly better results are achieved using a random number generator. This finding challenges the belief that only a small number of securities are required for diversification and shows that it is applicable only to a large sample. The implications are important given that many individual investors hold very few stocks in their portfolios.