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Un-diversifying during crises: Is it a good idea?

Author

Listed:
  • Margherita Giuzio

    (European Central Bank
    EBS Universität für Wirtschaft und Recht)

  • Sandra Paterlini

    (EBS Universität für Wirtschaft und Recht
    University of Trento)

Abstract

High levels of correlation among financial assets and extreme losses are typical during crises. In such situations, investing in few assets might be a better choice than holding diversified portfolios. We show that constraining the sparse $$\ell _q$$ ℓ q -norm of portfolio weights automatically controls diversification and selects portfolios with a small number of active weights and low risk, in presence of high correlation and volatility. We highlight the diversification relationships between the minimum variance portfolio, risk budgeting strategies and diversification-constrained portfolios. Finally, we show empirically that the $$\ell _q$$ ℓ q -strategy can successfully cope with bear markets by shrinking portfolio weights and total amount of shorting.

Suggested Citation

  • Margherita Giuzio & Sandra Paterlini, 2019. "Un-diversifying during crises: Is it a good idea?," Computational Management Science, Springer, vol. 16(3), pages 401-432, July.
    • Handle: RePEc:spr:comgts:v:16:y:2019:i:3:d:10.1007_s10287-018-0340-y
    DOI: 10.1007/s10287-018-0340-y
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    Cited by:

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    2. Giovanni Bonaccolto, 2021. "Quantile– based portfolios: post– model– selection estimation with alternative specifications," Computational Management Science, Springer, vol. 18(3), pages 355-383, July.
    3. Bonaccolto, Giovanni & Caporin, Massimiliano & Maillet, Bertrand B., 2022. "Dynamic large financial networks via conditional expected shortfalls," European Journal of Operational Research, Elsevier, vol. 298(1), pages 322-336.
    4. Giovanni Bonaccolto, 2019. "Critical Decisions for Asset Allocation via Penalized Quantile Regression," Papers 1908.04697, arXiv.org.
    5. Kremer, Philipp J. & Lee, Sangkyun & Bogdan, Małgorzata & Paterlini, Sandra, 2020. "Sparse portfolio selection via the sorted ℓ1-Norm," Journal of Banking & Finance, Elsevier, vol. 110(C).

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    More about this item

    Keywords

    Diversification; Regularization methods; Minimum variance; Sparsity;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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