Naive Versus Efficient Diversification

Naive Versus Efficient Diversification

ZAIMOVIC, Azra
ARNAUT-BERILO, Almira

This study investigates the performance of the naive 1/N portfolios relative to the mean-variance efficient portfolios and index replicating portfolios. We use the Sharpe ratio to measure the portfolio efficiency applied on sample and out-of sample portfolios from two capital markets, one developed (German) and one underdeveloped (Bosnian) in the pre- and post-crisis periods. We answer the question whether the active portfolio strategies are also more efficient. Our research heavy rely on the research from DeMiguel, Garlappi and Uppal (2009), who found that naive 1/N diversification outperform other optimizing portfolio models in the US stock market. Methods of determining efficient portfolios are mathematical and statistical problems, solved by applying convex, square or linear programming. According to the chosen methodology we applied our own software to solve optimization problems. We use Monte Carlo simulation to generate returns data in order to examine the persistence of the outperforming strategy in different periods. Keywords: Risk, Naive Diversification, Efficient Diversification. JEL Classification: G11

Article
PeerReviewed

ISSN 2303-4564

International Burch University

2013-05-10

1497