Equally Diversified or Equally Weighted?

22 Pages Posted: 9 Jul 2020

See all articles by Gianluca Fusai

Gianluca Fusai

Università del Piemonte Orientale Dipartimento di Studi per l'Economia e l'Impresa; Sir John Cass Business School - City, University of London

Domenico Mignacca

Qatar Investment Authority

Andrea Nardon

Sarasin & Partners LLP

Ben Human

Sarasin & Partners

Date Written: June 16, 2020

Abstract

The aim of this paper is to shed new light on the concept of diversification showing that it is not necessarily related to the reduction of the volatility of a portfolio, as it is commonly perceived. We introduce a diversification index that exploits the decomposition of portfolio volatility into undiversified volatility and a diversification component. The diversification component offsets the undiversified part leaving as a final result the portfolio volatility itself. Our decomposition has a clear statistical interpretation because it relates the diversification component to the so-called partial covariances, i.e. the covariances between the residuals of the regressions of the weighted asset returns with respect to the portfolio return. On this basis, we advocate the construction of an equally diversified portfolio versus an equally weighted portfolio. An empirical analysis illustrates the superior performance of the equally diversified portfolios with respect to the equally weighted portfolio.

Keywords: Diversification Measure, Portfolio Allocation, Risk Contribution, Euler decomposition

JEL Classification: G10, G11, D81

Suggested Citation

Fusai, Gianluca and Mignacca, Domenico and Nardon, Andrea and Human, Ben, Equally Diversified or Equally Weighted? (June 16, 2020). Available at SSRN: https://ssrn.com/abstract=3628585 or http://dx.doi.org/10.2139/ssrn.3628585

Gianluca Fusai (Contact Author)

Università del Piemonte Orientale Dipartimento di Studi per l'Economia e l'Impresa ( email )

Via Perrone, 18
Novara, 28100
Italy

HOME PAGE: http://https://upobook.uniupo.it/gianluca.fusai

Sir John Cass Business School - City, University of London ( email )

106 Bunhill Row
London, EC2Y 8HB
Great Britain

HOME PAGE: http:// www.cass.city.ac.uk/experts/G.Fusai

Domenico Mignacca

Qatar Investment Authority ( email )

doha
Qatar

Andrea Nardon

Sarasin & Partners LLP ( email )

Ben Human

Sarasin & Partners ( email )

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