How much diversification potential is there in a single market? Evidence from the Australian Stock Exchange

TL;DR

This paper evaluates the diversification potential within the Australian Stock Exchange from 2000 to 2014 using four methods, revealing a decline in diversification capacity prior to the 2008 financial crisis and during subsequent crises.

Contribution

It introduces four methods, including two based on principal component analysis, to assess diversification potential within a single market.

Findings

Diversification potential declined before the 2008 crisis

Potential further decreased during the 2011 European debt crisis

Methods showed consistent results across the studied period

Abstract

We present four methods of assessing the diversification potential within a stock market, two of these are based on principal component analysis. They were applied to the Australian stock exchange for the years 2000 to 2014 and all show a consistent picture. The potential for diversification declined almost monotonically in the three years prior to the 2008 financial crisis. On one of the measures the diversification potential declined even further in the 2011 European debt crisis and the American credit downgrade.