A New Formulation of Maximum Diversification Indexation Using Rao's Quadratic Entropy

CRREP working paper 2015-09

27 Pages Posted: 30 Mar 2018

See all articles by Benoit Carmichael

Benoit Carmichael

Université Laval

Gilles Boevi Koumou

Université Mohammed VI Polytechnique

Kevin Moran

Laval University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 25, 2015

Abstract

This paper proposes a new formulation of the Maximum Diversification indexation strategy based on Rao’s Quadratic Entropy (RQE). It clarifies the investment problem underlying the Most Diversified Portfolio (MDP) formed with this strategy, identifies the source of the MDP’s out-of-sample performance, and suggests dimensions along which this performance can be improved. We show that these potential improvements are quantitatively important and are robust to portfolio turnover, portfolio risk, estimation window, and covariance matrix estimation.

Keywords: Rao’s Quadratic Entropy, Portfolio Diversification, Maximum Diversification Indexation, Diversification Ratio, Most Diversified Portfolio

JEL Classification: G11

Suggested Citation

Carmichael, Benoit and Koumou, Gilles and Moran, Kevin, A New Formulation of Maximum Diversification Indexation Using Rao's Quadratic Entropy (September 25, 2015). CRREP working paper 2015-09, Available at SSRN: https://ssrn.com/abstract=3149033 or http://dx.doi.org/10.2139/ssrn.3149033

Benoit Carmichael (Contact Author)

Université Laval ( email )

Quebec G1K 7P4
Canada

Gilles Koumou

Université Mohammed VI Polytechnique ( email )

Rabat
Morocco

Kevin Moran

Laval University - Department of Economics ( email )

2325 Rue de l'Université
Ste-Foy, Quebec G1K 7P4 G1K 7P4
Canada

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