Diversification analysis

1. You are required to randomly select listed Australian firms and collect their stock price data from Use Yahoo! Finance.You are asked to give advice for your clients regarding how many stocks are required to have a diversified portfolio in Australian stock market. Using the datafrom Jan 2000 to Dec 2015, you construct equally weighted portfolios which consist of 1, 5, 10, 20, and up to a certain number of randomly chosen stocks to show the diversification effect. You need to show this diversification effect graphically.

2. Plot a market portfolio in the above figure that you created. Give some comments whether your portfolios are fully diversified.

3. We select different data span, from Aug 2007 to Dec 2010, construct portfolios that have same stock holdings as in the above question. The new data period can be viewed as the recent financial crisis period. Plot the risk of portfolios against the number of stocks included as in the above question. Interpret your observation and give potential reasons for the change in the graph if there is any. 

4. The principle that marginal costs should be compared to marginal benefits in determining the optimal levels of production or consumption is fundamental to economic theory. The fact that "almost all" of the portfolio's unsystematic risk is eliminated when it contains 10 or 100 stocks is meaningless when presented by itself. Discuss how we can analyse this marginal benefit/cost relation in diversification.