Realized Diversification Benefits of Risk Portfolio Models

Wan-Jiun Paul Chiou, Wen-Yi Lee and Jing-Rung Yu

Chapter 4 in Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives:In 4 Volumes, 2024, pp 171-190 from World Scientific Publishing Co. Pte. Ltd.

Abstract: In this chapter, we apply various portfolio models to rebalance portfolios and further analyze their realized performance, including mean-variance (MV), conditional value-at-risk (CVaR), and Omega models. To ensure feasibility, we consider the transaction costs and the optimization of short-selling weights. The empirical results using the daily returns of international funds across 21 countries over 20 years show that the risky portfolios realize higher performance than a naïve diversification, particularly the CVaR model with a confidence level of 95% despite their higher trading costs. The CVaR model, mainly focusing on controlling loss, yields higher performance than those that are based on trade-off between return and volatility, such as the mean−variance and Omega models. The Omega model, however, generates lower downside risk. The superiority of risky portfolios over the equally weighted diversification varies intertemporarily across various models. The excess returns of risky portfolios over the equally weighted diversification are larger when the market is volatile, such as the periods of the subprime mortgage financial crisis and the 2020 COVID-19 recession.

Keywords: Financial Accounting; Financial Auditing; Mutual Funds; Hedge Funds; Asset Pricing; Options; Portfolio Analysis; Risk Management; Investment Analysis; Momentum Analysis; Behavior Analysis; Futures; Index Futures; CDCs; Financial Econometrics; Statistics; Financial Derivatives; Financial Accounting (search for similar items in EconPapers)
JEL-codes: G1 G11 G12 G3 M41 M42 (search for similar items in EconPapers)
Date: 2024
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