Portfolio diversification: application & comparison of different strategies.

Abstract

Investing, by its very nature, always contains risk. The future returns are uncertain, which means that an asset's value may grow slower than expected or even be diminished. Diversification is one of the major techniques for reducing investment risk. It means that an investor can reduce her portfolio risk by selecting a variety of assets. In finance, diversification is applied with different methods. This paper's purpose is to present some of those methods and compare their results. The data that will be used are collected for the five years period 2008-2013 and include the prices and returns of the stock indices of all the countries in the Eurozone. Firstly, risk minimized portfolios will be made with the classical mean variance portfolio method. Next, going one step further, portfolios that also minimize risk will be created, but instead of simple correlations, long-run correlations will be used between the assets. The final method that will be tested is the construction of portfolios via cointegration. All the above methods will be compared with each other and the benchmark.