Simulation of Portfolio Returns: Varying Numbers of Securities and Holding Periods

Abstract

Variability may be measured around the long-run market return by combining the welldeveloped area of security diversification with the notion of time diversification. This nontraditional concept of diversifiable risk is illustrated with results of a very large scale simulation. The results are very general since the data used in the simulation consist of all firms on the Center for Research in Security Prices (CRSP) monthly return file from January 1926 through December 1977. 28The Journal ofFinancial Research diversification and diversifiable risk. We use the long-run market rate of return as a proxy for the investor's expected rate of return. Risk is the possibility of a portfolio return being different from what was expected. Deviations away from this long-run market return could occur because the securities held in the portfolio were not representative of the market (lack of security diversification) or because the time period the portfolio is held is not representative of the long-run market performance (lack of time diversification). This dual diversification concept was recently developed by Lloyd and Haney (1980), although some of the concepts were explored by Tobin (1965) much earlier. This paper will empirically explore the effects of both kinds of diversification, their relative importance, and the possibility of trading off one kind of diversification for another.