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Efficient diversification

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Definition of Efficient diversification

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Efficient diversification

The organizing principle of modern portfolio theory, which maintains that any riskaverse
investor will search for the highest expected return for any level of portfolio risk.

Related Terms:

Modern portfolio theory

Principles underlying the analysis and evaluation of rational portfolio choices
based on risk-return trade-offs and efficient diversification.

Beta coefficient

A measurement of the extent to which the returns on a given stock move with stock market.

coefficient of correlation

a measure of dispersion that indicates the degree of relative association existing between two variables

Coefficient of determination

A measure of the goodness of fit of the relationship between the dependent and
independent variables in a regression analysis; for instance, the percentage of variation in the return of an
asset explained by the market portfolio return.

coefficient of determination

a measure of dispersion that
indicates the “goodness of fit” of the actual observations
to the least squares regression line; indicates what proportion
of the total variation in y is explained by the regression model

coefficient of variation

a measure of risk used when the standard deviations for multiple projects are approximately
the same but the expected values are significantly different

Correlation coefficient

A standardized statistical measure of the dependence of two random variables,
defined as the covariance divided by the standard deviations of two variables.

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Correlation Coefficient

A measure of the tendency of two variables to change values

Correlation coefficient

A statistic in which the covariance is scaled to a
value between minus one (perfect negative correlation) and plus one (perfect
positive correlation).


Dividing investment funds among a variety of securities with different risk, reward, and
correlation statistics so as to minimize unsystematic risk.


The process of spreading a portfolio over many investments to
avoid excessive exposure to any one source of risk


Strategy designed to reduce risk by spreading the portfolio across many investments.


Investing so that all your eggs are not in the same basket. By spreading your investments over different kinds of investments, you cushion your portfolio against sudden swings in any one area. Segregated equity funds have become a popular and secure way for average investors to get the benefits of greater diversification.


An investment technique intended to minimize risk by utilizing a wide variety of investments within a portfolio. In a diversified portfolio, a decline in the value of one investment, for example, should be offset by the strength of other investments.

Efficient capital market

A market in which new information is very quickly reflected accurately in share

efficient capital markets

Financial markets in which security prices rapidly reflect all relevant information about asset values.

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Efficient frontier

The combinations of securities portfolios that maximize expected return for any level of
expected risk, or that minimizes expected risk for any level of expected return.

Efficient frontier

A graph representing a set of portfolios that maximizes
expected return at each level of portfolio risk. See Markowitz model.

Efficient Market Hypothesis

In general the hypothesis states that all relevant information is fully and
immediately reflected in a security's market price thereby assuming that an investor will obtain an equilibrium
rate of return. In other words, an investor should not expect to earn an abnormal return (above the market
return) through either technical analysis or fundamental analysis. Three forms of efficient market hypothesis
exist: weak form (stock prices reflect all information of past prices), semi-strong form (stock prices reflect all
publicly available information) and strong form (stock prices reflect all relevant information including insider

Efficient Markets Hypothesis

The hypothesis that securities are typically in equilibrium--that they are fairly priced in the sense that the price reflects all publicly available information on the security.

Efficient portfolio

A portfolio that provides the greatest expected return for a given level of risk (i.e. standard
deviation), or equivalently, the lowest risk for a given expected return.
efficient set Graph representing a set of portfolios that maximize expected return at each level of portfolio

Information Coefficient (IC)

The correlation between predicted and actual stock returns, sometimes used to
measure the value of a financial analyst. An IC of 1.0 indicates a perfect linear relationship between predicted
and actual returns, while an IC of 0.0 indicates no linear relationship.

input-output coefficient

a number (prefaced as a multiplier
to an unknown variable) that indicates the rate at which each
decision variable uses up (or depletes) the scarce resource

Internally efficient market

Operationally efficient market.

International diversification

The attempt to reduce risk by investing in the more than one nation. By
diversifying across nations whose economic cycles are not perfectly correlated, investors can typically reduce
the variability of their returns.

Liquidity diversification

Investing in a variety of maturities to reduce the price risk to which holding long
bonds exposes the investor.

Magic of diversification

The effective reduction of risk (variance) of a portfolio, achieved without reduction
to expected returns through the combination of assets with low or negative correlations (covariances).
Related: Markowitz diversification

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Markowitz diversification

A strategy that seeks to combine assets a portfolio with returns that are less than
perfectly positively correlated, in an effort to lower portfolio risk (variance) without sacrificing return.
Related: naive diversification

Markowitz efficient frontier

The graphical depiction of the Markowitz efficient set of portfolios
representing the boundary of the set of feasible portfolios that have the maximum return for a given level of
risk. Any portfolios above the frontier cannot be achieved. Any below the frontier are dominated by
Markowitz efficient portfolios.

Markowitz efficient portfolio

Also called a mean-variance efficient portfolio, a portfolio that has the highest
expected return at a given level of risk.

Markowitz efficient set of portfolios

The collection of all efficient portfolios, graphically referred to as the
Markowitz efficient frontier.

Mean-variance efficient portfolio

Related: Markowitz efficient portfolio

Naive diversification

A strategy whereby an investor simply invests in a number of different assets and
hopes that the variance of the expected return on the portfolio is lowered.
Related: Markowitz diversification.

Operationally efficient market

Also called an internally efficient market, one in which investors can obtain
transactions services that reflect the true costs associated with furnishing those services.

Portfolio Diversification

See diversification

Principal of diversification

Highly diversified portfolios will have negligible unsystematic risk. In other
words, unsystematic risks disappear in portfolios, and only systematic risks survive.

Market Risk

The part of security's risk that cannot be eliminated by diversification. It is measured by the beta coefficient.







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