How many small firms are enough?

How many small firms are enough?

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Article ID: iaor201522785
Volume: 7
Issue: 4
Start Page Number: 341
End Page Number: 349
Publication Date: Dec 1984
Journal: Journal of Financial Research
Authors: ,
Keywords: investment, risk
Abstract:

Individual investors are undiversified, holding on average less than four securities in their personal portfolios. The small firm literature focuses on CAPM (systematic risk, full diversification concept) premia, and the actual performance of small firm portfolios held by investors is overstated because of the presence of unsystematic risk. This paper illustrates the magnitudes of total risk for small and large firms, and the behavior of such measures as portfolio size is altered. Small firms contain more risk as shown by the finding that a diversified portfolio of small firms has greater variability than a single, typical large firm. While small firms outperform large firms, investors should be aware of the implications for small firm undiversified portfolios. Because small firms contain large amounts of unsystematic risk, diversification is important if investors are going to capture the small firm premia reported in the literature.

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