Briefly define under diversification and excessive trading, differentiate them from each other and describe how they...

Briefly define under diversification and excessive trading, differentiate them from each other and describe how they would be applied for an individual investor.

Expert Solution

Under diversification means that when there is not appropriate number of stocks which are allocated properly into the portfolio and there are lesser number of stocks which have been allocated to the portfolio then there is is not proper elimination of unsystematic risk in the portfolio and it will keep on existing with systematic risk.

Excessive trading will mean that when trading positions are based upon leveraging and unnecessary risk exposure into derivative contracts which can significantly wipe out the value of the investments and this can pose a capital erosion risk and blow the entire capital.

These both will be representing a unnecessary risk exposure but under-diversification means not taking adequate risk exposure and excessive trading will mean that taking unnecessary risk exposure.

Under diversification will be representing the risk aversion iof the investor whereas excessive trading will reflect that the overconfidence of the investor.

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