Portfolio Diversification Effects of Downside Risk
AbstractRisk managers use portfolios to diversify away the unpriced risk of individual securities. In this article we compare the benefits of portfolio diversification for downside risk in case returns are normally distributed with the case of fat-tailed distributed returns. The downside risk of a security is decomposed into a part which is attributable to the market risk, an idiosyncratic part, and a second independent factor. We show that the fat-tailed-based downside risk, measured as value-at-risk (VaR), should decline more rapidly than the normal-based VaR. This result is confirmed empirically. Copyright 2005, Oxford University Press.
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Bibliographic InfoArticle provided by Society for Financial Econometrics in its journal Journal of Financial Econometrics.
Volume (Year): 3 (2005)
Issue (Month): 1 ()
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- Moore, Kyle & Sun, Pengei & de Vries, Casper G. & Zhou, Chen, 2013. "The drivers of downside equity tail risk," MPRA Paper 45591, University Library of Munich, Germany.
- Tee, Kai-Hong, 2009. "The effect of downside risk reduction on UK equity portfolios included with Managed Futures Funds," International Review of Financial Analysis, Elsevier, Elsevier, vol. 18(5), pages 303-310, December.
- DiTraglia, Francis J. & Gerlach, Jeffrey R., 2013. "Portfolio selection: An extreme value approach," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(2), pages 305-323.
- Zhou, Chen, 2010. "Dependence structure of risk factors and diversification effects," Insurance: Mathematics and Economics, Elsevier, vol. 46(3), pages 531-540, June.
- Moore, Kyle & Sun, Pengfei & de Vries, Casper G. & Zhou, Chen, 2013. "The cross-section of tail risks in stock returns," MPRA Paper 45592, University Library of Munich, Germany.
- Chen Zou, 2009. "Dependence structure of risk factors and diversification effects," DNB Working Papers, Netherlands Central Bank, Research Department 219, Netherlands Central Bank, Research Department.
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