DP14119 All the bottles in one basket? Diversification and product portfolio composition

Author(s): Richard Friberg
Publication Date: November 2019
Keyword(s): Diversification, Enterprise risk management, Monte Carlo, Product portfolios, Risk-return relation
JEL(s):
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14119

This paper develops a framework using Monte Carlo simulation to examine risk/return properties of intra-industry product portfolio composition and diversification. We use product-level data covering all Swedish sales of alcoholic beverages to describe the risk profiles of wholesalers and how they are affected by actual and hypothetical changes to product portfolios. Using a large number of counterfactual portfolios we quantify the diversification benefits of different product portfolio compositions. In this market the most important reductions in variability come from focusing on domestic products and from focusing on product categories that have low variability. The number of products also has a large effect in the simulations, moving from a portfolio of 10 products to one of 20 products cuts standard deviation of cash flows in relation to mean cash flows by more than half. The concentration of import origins plays a minor quantitative role on risk/return profiles in this market.