A Study about the Effect of Portfolio Diversification on Downside Risk in Tehran Stock Exchange (TSE)

Diversification is one of the risk management tools and its important advantage is when the diversification increased, nonsystematic risk is reduced without reducing return, but well-diversified portfolios associated with the costs of trading, maintenance, and regulatory. Besides traditional risk measures, such as standard deviation and beta, failing to distinguish between risk and downside risk from the perspective is not appropriate metrics to measure risks and reflect the risks of what the human mind understands. But downside risk measures give downside volatilities investor's aim. This study aims to determine the relationship between diversification and downside risk in order to reduce nonsystematic risk on the Tehran Stock Exchange Market. The data used the time series of daily returns of 104 firms in the 3.5 years period. Using this data, portfolios with 1 to 20 stocks is formed based a simple strategy, downside risk measures such as semi-variance below the target, the target semi-SD, value at risk, expected shortfall and Lower Partial Moments were calculated for each portfolio, the relationship of each of these criteria and the number of stocks in the portfolio were tested. The result of this study indicates that the negative correlation between diversification and downside risk.