Diversification of Common Stock Investments Through Limited Diversification Portfolios (LDP)
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Date
2005-06
Authors
Theng Theng, Koh
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Abstract
Most investors are risk averse who intends to minimize overall risk. They will select
the portfolio with the lower level of risk given that two portfolios are equal rates of
return. Diversification is useful for a risk averse investors as to form their optimal
portfolios. In this study, we analyze 12 securities listed at the Main Board of Bursa
Malaysia of the following industries: Consumer Products, Industrial Products, Trading
of Services, Technology, Finance and Plantations. The selected data were the high
closing price of 12 stocks traded in Bursa Malaysia from 01 January 2000 to 31
December 2004. This study focused on investment in common stocks and construct a
Limited Diversification Portfolio Model (LDP) by Jacob (1947). Using the formulae
by Szego (1980), we calculate the optimal risk level and make comparison for the
portfolios of different size. The statistical tests (F-test and t-test) applied here are
intended to detect differences in risk level among portfolios, of varying sizes. A
reference portfolio is selected to compare with other optimal portfolios if two
portfolios under study show significant differences in its risk level with portfolio with
different size. Also, once can analyze a portfolio robustness using the Minimax
Criterion. The results shown that Portfolios I, II and III are different in their optimal
risk levels in a statistically sense. However, the robustness criterion shown that
Portfolio IIC provides a robust portfolio. Portfolio IIC is a best-of-the-worst-risk
portfolio. This study concludes that, diversification in a limited portfolio investment
show differences in risk level for portfolios of different size. Investor can apply
statistical methods presented in this study to analyze and calculate risk level of
portfolios of different size. It assist small investor to make decision in the creation of
optimal portfolio and to achieve diversification even with limited resources. The
robustness of portfolio is another criterion (qualitative aspect) a small investor can
consider to make a best selection of optimal portfolio.
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Keywords
Stock Investment , Limited Diversification Portfolios (LDP)