Mean-variance versus naïve diversification: The role of mispricing

Cheng Yan and Huazhu Zhang

Journal of International Financial Markets, Institutions and Money, 2017, vol. 48, issue C, 61-81

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.

Keywords: Finance; Portfolio choice; Mean-variance; 1/N naïve diversification; Mispricing (search for similar items in EconPapers)
JEL-codes: C44 D81 G11 G12 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:48:y:2017:i:c:p:61-81

DOI: 10.1016/j.intfin.2016.12.005

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