Diversification in Small Portfolios
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For various reasons, investors tend to hold a rather small number of assets. In this chapter, a method has been presented to approach the associated NP hard optimization problem of selecting the optimal set of assets under a given market situation and expectations. The main results from this empirical study are twofold: (i) the well known fact of decreasing marginal contribution to diversification is not only confirmed, but can be exploited by identifying those assets that, in combination, offer the highest risk premium; (ii) it has been shown that alternative rules, frequently found in practice, are likely to underperform as they offer solutions with risk premia lower than would be possible under the same constraints and market situations.
KeywordsRisk Premium Knapsack Problem Sharpe Ratio Capital Asset Price Model Cardinality Constraint
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