The impact of portfolio diversification on mean reverting components of stock indices

Gordon Y N TANG*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

Positive autocorrelations are introduced into stock index portfolios when they are formed from individual stock indices while negative autocorrelations are induced in returns by increasing the investment horizon. Using monthly data of six international stock indices, this paper examines the diversification effect with different investment horizons on autocorrelations of stock index portfolios. The results show that portfolio diversification does not alter the impact of the investment horizon on autocorrelations. Different investment horizons, however, have great impact on the diversification effect on autocorrelations. With short (long) horizons, the average autocorrelation coefficient increases (decreases) with an increase in the portfolio size, suggesting that mean-reverting component dominates the delayed adjustment effect in long horizons and vice versa in short horizons. Our results are robust across two 10-year sub-periods.

Original languageEnglish
Pages (from-to)41-57
Number of pages17
JournalFinancial Engineering and the Japanese Markets
Volume3
Issue number1
DOIs
Publication statusPublished - Feb 1996

Scopus Subject Areas

  • Economics, Econometrics and Finance(all)

User-Defined Keywords

  • Diversification
  • investment horizon
  • mean reversion

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