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. This discussion paper has resulted in a publication in the Journal of Financial Econometrics . (2005, 3(1), 107-125.)
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 05-008/2.
Date of creation: 17 Jan 2005
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Diversification; Value-at-Risk; Decomposition;
Find related papers by JEL classification:
- G0 - Financial Economics - - General
- G1 - Financial Economics - - General Financial Markets
- C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables
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