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Portfolio Diversification Essay

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Portfolio theory refers to the notion that the return, as measured by variance, for a given risk could be maximized by efficiently diversifying portfolios (Tobin 1981). This theory takes into account the stocks involved, and their variances and covariances. These affect the risks faced by a stock portfolio. The value of portfolio diversification lies in the reduction of risks involved (Statman 1987).

            There are many articles discussing portfolio diversification in general, and as applied to certain specific circumstances. Below are articles that discuss portfolio diversification, its dynamics, and effects.

            There are many articles discussing the basics of portfolio diversification. One such article was the one written by Conybeare. In this article, Conybeare explains how the theory of portfolio diversification involves both risks and returns. He also notes that this theory allows the formulation of various combinations of risks and returns, depending on the preference of the investor (Conybeare 1992).

            However, Conybeare takes his discussion up a notch. Following the basic principles of portfolio diversification, Conybeare suggests that the theory could be applied to other endeavors, such as military alliances. He thereby makes analogies and comparisons between military alliances and business ventures as subjects of portfolio diversification. He concludes that using a portfolio analysis could lead to a very efficient way of determining good military alliances (Conybeare 1992).

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            Since there are many different kinds of business strategies, articles like that written by Dess, Gupta, Hennart and Hill discusses different issues involved at different levels of strategy research, such as business, corporate, and international levels. The authors likewise looked into possibilities of integration of different strategies, such as incorporation of different dimensions of strategy. One such strategy explored by this article is portfolio diversification. They therefore discuss in this article portfolio diversification, along with other business strategies that reduce risk (Dess, Gupta, Hennart & Hill 1995).

            Gaumnitz’ article is concerned with determining the number of securities necessary for diversification. Specifically, it tests the hypothesis that there is a limit to the number of securities that could improve a portfolio’s return over risk. The results of the study were positive, and showed that there is certain point where the number of common stocks would no longer affect the variability of risk involved (Gaumnitz 1969).

            Klemkosky’s and Martin’s article explains the portfolio approach and explains the place of risk in a portfolio analysis. The authors of this article discuss the nature of portfolio approach. Moreover, they state the general consensus that risk is an integral part of portfolio analysis. Finally, the authors discuss the relationship between the process of diversification and portfolio size (Klemkosky & Martin 1975).

            Portfolio diversification can be observed in the process of industrialization. This endeavor requires certain factors that affect the effects of diversification on business. In the article written by Brewer and Moomaw, they discuss a study they conducted to determine the relationships of factors involved in industrial diversification. These factors include economic stability and city size. They also posit that disagreements in findings of various studies on the relationship of economic stability and city size could be attributed to differences in definition of diversification used in such studies. Finally, this article suggests that instability in business could be explained by portfolio diversification, among other factors (Brewer & Moomaw 1985).

            Portfolio diversification could be taken in a large scale, such as a global scale. Thus, in the article written by Coe, one way of global portfolio diversification is discussed. Specifically, Coe’s article suggests portfolio diversification by purchasing shares of individual corporations, pooling of funds in investment companies, and investing in American Depository Receipts. After analyzing the performance of companies using these varied forms of investments over a nine-year timeframe, Coe concluded that investment in American Depository Receipts may be the best option since it provides better risk-adjusted returns (Coe 2002).

            On the other hand, the article of Cosset and Suret concerns itself with the task of explaining the benefits of portfolio investment. Cosset and Suret explain the benefits of portfolio investment, particularly in politically risky countries. The benefits were evaluated using data on ratings of political risk and international stock returns for a period of nine years. The authors concluded based on empirical findings that international portfolio diversification reduces the risk for politically risky countries (Cosset & Suret 1995).

            Lessard’s article is very specific. It reports a study that aims to gain knowledge that would help in the determination of the possible gain from portfolio diversification in four Latin American countries. These countries include Chile, Argentina, Colombia, and Brazil. These countries were selected because they are developing countries, which share the character of having limited savings allotted for investment. To determine the extent of potential gains from portfolio diversification, different portfolio strategies were examined and tested (Lessard 1971).

            Another relevant article in portfolio diversification is that written by Sirmans and Worsala (2003). This article is a discussion and critical review of the literature on the subject of international direct investment, particularly in real estate. This article is a response to the perception that there is no study that analyzes the benefits of diversification in international real estate. This article likewise notes that real estate assets may be analyzed in two ways: in the context of mixed-asset portfolio and real-estate-only portfolio. Thus, this article explores the different ways by which portfolio diversification could be applied in the context of real estate international investment (Sirmans & Worzala 2003).

            Statman’s article seeks the answer to the query stated in its title, which is the required number of stocks to make a diversified portfolio. Statman challenges the widely accepted theory of Evans and Archer that about ten stocks would be sufficient. Statman posits in this article that 30 stocks or more are required to complete a well-diversified portfolio (Statman 1987).

            Tobin’s article, on the other hand, reviews the history of the theory of portfolio diversification, specifically Markowitz’s formulation of the mean-variance analysis of portfolio decisions in the early 1950s. In this article, Tobin also discusses how his theory of portfolio diversification differs from that of Markowitz’s (Tobin 1981).

            Westerfield’s article aims to reexamine the query as to the effect of portfolio diversification on the distribution of portfolio returns. Westerfield notes in this article that there have been studies claiming that portfolio diversification has the effect of reducing portfolio return variability. However, he believes that variability could have many different definitions, and such differences could account for the opinion that diversification reduced return viability (Westerfield 1975).

            Finally, Yang and Hyland critically examines the different sources of imitation among firms. The authors cite three levels of sources of imitation, namely, firm level, market level, and industry level. Portfolio diversification is explored by these two authors as one of the ways of imitation employed by different firms (Yang & Hyland 2006).


Brewer, H.L. & Moomaw, R. L. 1985, ‘A Note on Population Size, Industrial         Diversification, and Regional Economic Instability’, Urban Studies, vol. 22, no. 4,           pp. 349-354.

Coe, T. S. 2002, ‘International Portfolio Diversification: A Comparison of ADRs and       Closed-End Country Funds’, Journal of Emerging Market Finance, vol. 1, no. 1,            pp. 31-46.

Conybeare, J. A. C. 1992, ‘A Portfolio Diversification Model of Alliances’, Journal of      Conflict Resolution, vol. 36, no. 1, pp. 53-85

Cosset, J. & Suret, J. 1995, ‘Political Risk and the Benefits of International Portfolio             Diversification’, Journal of International Business Studies, vol. 26, no. 2, pp. 301-           318.

Dess, G. G., Gupta, A., Hennart, J., Hill, C. W. L. 1995, ‘Conducting and Integrating     Strategy Research at the International, Corporate, and Business Levels: Issues     and Directions’, Journal of Management, Vol. 21, No. 3, 357-393.

Gaumnitz, J. E. 1969, ‘Investment Diversification Under Uncertainty: An Examination of           the Number of Securities in a Diversified Portfolio’, The Journal of Finance, vol.        24, no. 4, pp. 725-726.

Klemkosky, R. C. & Martin, J. D. 1975, ‘The Effect of Market Risk on Portfolio     Diversification’, The Journal of Finance, vol. 30, no. 1, pp. 147-154.

Lessard, D. R. 1971, ‘Multinational Portfolio Diversification for Developing Countries’,   The Journal of Finance, vol. 26, no. 3, pp. 798-799.

Sirmans, C.F. & Worzala, E. 2003, ‘International Direct Real Estate Investment: A         Review of the Literature’, Urban Studies, vol. 40, no. 5-6, pp. 1081-1114.

Statman, M. 1987, ‘How Many Stocks Make a Diversified Portfolio?’, The Journal of      Financial and Quantitative Analysis, vol. 22, no. 3, pp. 353-363.

Tobin, J. 1981, ‘Portfolio Theory’, Science, New Series, vol. 214, no. 4524, p. 974.

Westerfield, R. 1975, ‘How Diversification Reduces Risk: Some Further Evidence’, The             Journal of Financial and Quantitative Analysis, vol. 10, no. 4.

Yang, M. & Hyland, M. 2006, ‘Who Do Firms Imitate? A Multilevel Approach to   Examining Sources of Imitation in the Choice of Mergers and Acquisitions’,         Journal of Management, Vol. 32, No. 3, 381-399.

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