Rao’s quadratic entropy and maximum diversification indexation

Benoît Carmichael, Nettey Boevi Gilles Koumou () and Kevin Moran

Quantitative Finance, 2018, vol. 18, issue 6, 1017-1031

Abstract: This paper proposes a new formulation of the maximum diversification indexation strategy based on Rao’s Quadratic Entropy. It clarifies the investment problem underlying this diversification strategy, identifies the source of its out-of-sample performance, and suggests new dimensions along which this performance can be improved. We show that these potential improvements are quantitatively important and are robust to portfolio turnover, portfolio risk, estimation window, and covariance matrix estimation.

Date: 2018
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DOI: 10.1080/14697688.2017.1383625

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