Notes On The Value Of Diversification

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The value of diversification Introduction Diversification is worth more than a word. It works on reducing the total risk of a portfolio with different asset types. But what contributes to the success of portfolio diversification? A large size of portfolio? A variety types of asset allocation? Adding international investment? Numerous of risk factors? They are all indicators of a well-diversified portfolio. But it is hard to achieve a perfectly diversified portfolio in reality because you cannot diversify all types of risk. Following, we will discuss about the advantages and disadvantages of diversification in portfolio management under circumstances. On one hand, some mention that dynamic and numerous asset allocations in the portfolio will reduce idiosyncratic risk and some level of market risk. While some also suggest benefit exists of introducing multi-factor pricing models to cover different risk factors. On the other hand, arguments arise demonstrating adding international investment may disappoint investors because foreign markets could be correlated and moved together in a global world. Another disadvantage further defined will be the correlated asset allocations weaken the effect of diversification. At the end, conclusion will be drawn to support the useness of diversification. Dynamic and numerous asset allocation benefits Since there are two main types of risk we need to account for: systematic risk and idiosyncratic risk, the easiest one to be diversified away is
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