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A further examination of the effect of diversification on the stability of portfolio betas

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  • R. D. Brooks
  • R. W. Faff
  • M. A. M. Gangemi
  • J. H. H. Lee

Abstract

Although many studies have found a non-trivial incidence of beta instability for individual common stocks, there exists controversy over the beta stability characteristics to expect in portfolios formed from these stocks. The extent is examined to which portfolio formation can diversify away beta instability. Specifically, although a constant beta for the market portfolio is acknowledged as the trivial limiting case, particular attention is devoted to shedding light on the speed with which diversification can deliver a reasonable expectation of stable portfolio betas. The issue is examined by forming portfolios which mix together constant beta stocks and varying beta stocks. The evidence is generally consistent with the presence of a diversification effect, but as the portfolio size increases, results do show a greater proportion of constant beta stocks are needed to maintain the relative stability of the portfolio.

Suggested Citation

  • R. D. Brooks & R. W. Faff & M. A. M. Gangemi & J. H. H. Lee, 1997. "A further examination of the effect of diversification on the stability of portfolio betas," Applied Financial Economics, Taylor & Francis Journals, vol. 7(1), pages 9-14.
    • Handle: RePEc:taf:apfiec:v:7:y:1997:i:1:p:9-14
    DOI: 10.1080/096031097333808
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    References listed on IDEAS

    as
    1. Fabozzi, Frank J. & Francis, Jack Clark, 1978. "Beta as a Random Coefficient," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(1), pages 101-116, March.
    2. Sunder, Shyam, 1980. "Stationarity of Market Risk: Random Coefficients Tests for Individual Stocks," Journal of Finance, American Finance Association, vol. 35(4), pages 883-896, September.
    3. Brooks, Robert D. & Faff, Robert W. & Lee, John H. H., 1995. "Beta stability and portfolio formation," Pacific-Basin Finance Journal, Elsevier, vol. 3(1), pages 145-146, May.
    4. Chen, Son-Nan & Keown, Arthur J, 1981. "Risk Decomposition and Portfolio Diversification When Beta Is Nonstationary: A Note," Journal of Finance, American Finance Association, vol. 36(4), pages 941-947, September.
    5. Shively, Thomas S., 1988. "An analysis of tests for regression coefficient stability," Journal of Econometrics, Elsevier, vol. 39(3), pages 367-386, November.
    6. Collins, Daniel W & Ledolter, Johannes & Rayburn, Judy Dawson, 1987. "Some Further Evidence on the Stochastic Properties of Systematic Risk," The Journal of Business, University of Chicago Press, vol. 60(3), pages 425-448, July.
    7. Brooks, Robert D., 1993. "Alternative point-optimal tests for regression coefficient stability," Journal of Econometrics, Elsevier, vol. 57(1-3), pages 365-376.
    8. Bos, T & Newbold, P, 1984. "An Empirical Investigation of the Possibility of Stochastic Systematic Risk in the Market Model," The Journal of Business, University of Chicago Press, vol. 57(1), pages 35-41, January.
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    Cited by:

    1. Brooks, Robert D. & Faff, Robert W. & Ariff, Mohamed, 1998. "An investigation into the extent of beta instability in the Singapore stock market," Pacific-Basin Finance Journal, Elsevier, vol. 6(1-2), pages 87-101, May.
    2. Esteban González, María Victoria & Tusell Palmer, Fernando Jorge, 2009. "Predicting Betas: Two new methods," BILTOKI 1134-8984, Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística).

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