Quantifying the Skewness Loss of Diversification

Forthcoming in the Journal of Investment Management

Posted: 5 Jun 2018

See all articles by James X. Xiong

James X. Xiong

Morningstar Investment Management

Thomas M. Idzorek

Morningstar Investment Management

Date Written: May 22, 2018

Abstract

Diversification is widely viewed as the “only free lunch” of finance. Unbeknownst to the free lunch crowd, skewness is typically positive for individual stocks and negative for diversified portfolios and thus diversification is not free. This undesirable move from positive to negative skewness that comes with diversification is the skewness loss of diversification. We quantify the economic value of skewness loss using option pricing models, and show that skewness loss is a meaningful cost for investors with skewness preferences and short horizons.

Keywords: Diversification; Skewness Loss; Non-Normal Option Pricing

Suggested Citation

Xiong, James X. and Idzorek, Thomas, Quantifying the Skewness Loss of Diversification (May 22, 2018). Forthcoming in the Journal of Investment Management , Available at SSRN: https://ssrn.com/abstract=3183281

James X. Xiong (Contact Author)

Morningstar Investment Management ( email )

22 West Washington Street
Chicago, IL 60602
United States

Thomas Idzorek

Morningstar Investment Management ( email )

22 W Washington Street
Chicago, IL 60602
United States

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