The impact of heavy tails and comovements in downside-risk diversification

Jose Olmo
Authors registered in the RePEc Author Service: Jesus Gonzalo

UC3M Working papers. Economics from Universidad Carlos III de Madrid. Departamento de Economía

Abstract: This paper uncovers the factors influencing optimal asset allocation for downside-risk averse investors. These are comovements between assets, the product of marginal tail probabilities, and the tail index of the optimal portfolio. We measure these factors by using the Clayton copula to model comovements and extreme value theory to estimate shortfall probabilities. These techniques allow us to identify useless diversification strategies based on assets with different tail behaviour, and show that in case of financial distress the asset with heavier tail drives the return on the overall portfolio down. An application to financial indexes of UK and US shows that mean-variance and downside-risk averse investors construct different efficient portfolios.

Keywords: Comovements; Downside-risk; diversification; Copulas; Expected; shortfall; Heavy; tails; Lower; partial; moments; Shortfall; probability (search for similar items in EconPapers)
Date: 2007-02-08
New Economics Papers: this item is included in nep-rmg
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Working Paper: The impact of heavy tails and comovements in downside-risk diversification (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:cte:werepe:we20070208

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