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Using Four-Moment Tail Risk to Examine Financial and Commodity Instrument Diversification

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  • Leyuan You
  • Robert T. Daigler

Abstract

We consider the effect of higher moments on diversification, since most assets possess a potential for tail losses. In particular, we examine higher-moment Value-at-Risk measures for individual instruments and diversified portfolios. We find that a naïve futures portfolio is consistently superior to common stock indexes. As few as ten randomly chosen instruments diversify away 85% of the unsystematic four-moment tail risk. We also compare the two- and four-moment tail risks for different size portfolios. Finally, the tail risk for naïve portfolios varies much less over time than other portfolios. Copyright (c) 2010, The Eastern Finance Association.

Suggested Citation

  • Leyuan You & Robert T. Daigler, 2010. "Using Four-Moment Tail Risk to Examine Financial and Commodity Instrument Diversification," The Financial Review, Eastern Finance Association, vol. 45(4), pages 1101-1123, November.
  • Handle: RePEc:bla:finrev:v:45:y:2010:i:4:p:1101-1123
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    Cited by:

    1. Chin Man Chui & Jian Yang, 2012. "Extreme Correlation of Stock and Bond Futures Markets: International Evidence," The Financial Review, Eastern Finance Association, vol. 47(3), pages 565-587, August.
    2. repec:eee:asieco:v:52:y:2017:i:c:p:32-44 is not listed on IDEAS
    3. Simon Xu & Inchang Hwang & Francis In, 2016. "The Effect of Diversification on Tail Risk: Evidence from US Equity Mutual Fund Portfolios," International Review of Finance, International Review of Finance Ltd., vol. 16(3), pages 483-495, September.
    4. Bianchi, Robert J. & Drew, Michael E. & Fan, John Hua, 2015. "Combining momentum with reversal in commodity futures," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 423-444.
    5. Daskalaki, Charoula & Skiadopoulos, George, 2011. "Should investors include commodities in their portfolios after all? New evidence," Journal of Banking & Finance, Elsevier, vol. 35(10), pages 2606-2626, October.
    6. Desmoulins-Lebeault, François & Kharoubi-Rakotomalala, Cécile, 2012. "Non-Gaussian diversification: When size matters," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 1987-1996.
    7. Bredin, Don & Conlon, Thomas & Potì, Valerio, 2017. "The price of shelter - Downside risk reduction with precious metals," International Review of Financial Analysis, Elsevier, vol. 49(C), pages 48-58.
    8. P. Simmons & N. Tantisantiwong, 2014. "Equilibrium moment restrictions on asset returns: normal and crisis periods," The European Journal of Finance, Taylor & Francis Journals, vol. 20(11), pages 1064-1089, November.

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