Maximum Diversification Index

Diversification measures and the optimal number of Stocks in a portfolio: An information theoretic explanation

This paper provides a plausible explanation for why the optimum number of stocks in a portfolio is elusive, and suggests a way to determine this optimal number. Diversification is dependent on the number of stocks in a portfolio and the correlation structure. Adding stocks to a portfolio increases the level of diversification, and consequently leads to risk reduction. However the risk reduction effect dissipates after a certain number of stocks, beyond which additional stocks do not contribute to risk reduction.

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