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The Opportunity Cost of Holding a “Naive” Portfolio

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  • Alice A. Melkumian

    (Western Illinois University)

Abstract

The paper explores the effect of “naive” portfolio strategies on investors’ welfare. A “naive” portfolio as a sub-optimal investment strategy produces sub-optimal asset allocations that result in investors’ welfare losses. To measure those losses I compare sub-optimal portfolios with optimal portfolios using the proportionate opportunity cost with various CRRA utility functions. A vector autoregression is used to generate the joint distribution of asset returns. I show that the opportunity cost of investing in “naive” portfolios does not exceed 16.7% while investing in the optimal number of asset and does not exceed 20.4% while investing in a sub-optimal number of assets.

Suggested Citation

  • Alice A. Melkumian, 2012. "The Opportunity Cost of Holding a “Naive” Portfolio," Journal of Economic Insight, Missouri Valley Economic Association, vol. 38(1), pages 23-42.
    • Handle: RePEc:mve:journl:v:38:y:2012:i:1:p:23-42
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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