Market Capitalization Concentration & Its Impact on Diversification In The Aggregate Market Portfolio

Sammanfattning

This thesis examines how market capitalization concentration affects diversification benefits in the Swedish equity market over the period 1985–2022. While traditional theory suggests that higher concentration reduces diversification, this relationship remains empirically unclear. Using a comprehensive panel dataset of Swedish equities concentration is measured through Top 5, Top 10, and Herfindahl–Hirschman Index metrics, while diversification is captured by return dispersion and a variance based diversification ratio. The results show that higher concentration is consistently associated with increased dispersion and a higher diversification ratio. Decomposition analysis reveals that firm level variance increases more than market level variance, implying that idiosyncratic risk rises but is not fully transmitted to the market portfolio. As a result, diversification benefits increase despite higher concentration, highlighting a more nuanced relationship between market structure and diversification.