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Mean-Variance versus Naïve Diversification: The Role of Mispricing

Yan, C.; Zhang, H.

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Authors

C. Yan

H. Zhang



Abstract

We compare the equal-weight naïve 1/N portfolio with mean-variance strategies from the perspective of mispricing (alpha) and provide three new findings. First, we analytically show that the 1/N rule approaches the ex ante mean-variance efficient portfolio in the absence of mispricing. With mispricings, mean-variance strategies can overcome the difficulty brought by the imprecise parameter estimates and outperform 1/N by exploiting the mispricing. Second, with mispricings the 1/N rule is unlikely to outperform mean-variance strategies even when N is large, since mean-variance strategies have more opportunities to exploit mispricings. Third, minimum-variance strategies do not exploit mispricings and underperform the 1/N rule.

Citation

Yan, C., & Zhang, H. (2017). Mean-Variance versus Naïve Diversification: The Role of Mispricing. Journal of International Financial Markets, Institutions and Money, 48, 61-81. https://doi.org/10.1016/j.intfin.2016.12.005

Journal Article Type Article
Acceptance Date Dec 21, 2016
Online Publication Date Dec 29, 2016
Publication Date May 1, 2017
Deposit Date Jan 11, 2017
Publicly Available Date Dec 29, 2017
Journal Journal of International Financial Markets, Institutions and Money
Print ISSN 1042-4431
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 48
Pages 61-81
DOI https://doi.org/10.1016/j.intfin.2016.12.005
Public URL https://durham-repository.worktribe.com/output/1388799

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