The downside risk of heavy tails induces low diversification
Casper G. de Vries – Erasmus school of Economics

Actual portfolios contain fewer stocks than are implied by standard financial analysis that balances the costs of diversification against the benefits in terms of the standard deviation of the returns. Suppose a safety first investor cares about downside risk and recognizes the heavy tail feature of the asset return distributions. For this type of investor the optimal portfolio sizes are considerably smaller than traditional correlation based diversification analysis suggests. This is demonstrated empirically and analytically.


Casper G. de Vries

Casper G. de Vries holds the chair of Monetary Economics at the Erasmus School of Economics, Erasmus University Rotterdam, and co-heads the risk management program at the Duisenberg School of Finance. He is a fellow of the Tinbergen Instiutute and CESifo. His research interests are focused on international monetary issues, the issues surrounding the Euro, financial markets risk, risk management and systemic risk. In his research on financial risks, he has specialized in calculating the risks on extreme events by means of statistical extreme value analysis. To know more…

 

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