Using Four‐Moment Tail Risk to Examine Financial and Commodity Instrument Diversification

Leyuan You and Robert T. Daigler

The Financial Review, 2010, vol. 45, issue 4, 1101-1123

Abstract: We consider the effect of higher moments on diversification, since most assets possess a potential for tail losses. In particular, we examine higher‐moment Value‐at‐Risk measures for individual instruments and diversified portfolios. We find that a naïve futures portfolio is consistently superior to common stock indexes. As few as ten randomly chosen instruments diversify away 85% of the unsystematic four‐moment tail risk. We also compare the two‐ and four‐moment tail risks for different size portfolios. Finally, the tail risk for naïve portfolios varies much less over time than other portfolios.

Date: 2010
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