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Simulating and calibrating diversification against black swans

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  • Hyung, Namwon
  • de Vries, Casper G.

Abstract

An investor concerned with the downside risk of a black swan only needs a small portfolio to reap the benefits from diversification. This matches actual portfolio sizes, but does contrast with received wisdom from mean–variance analysis and intuition regarding fat tailed distributed returns. The concern for downside risk and the fat tail property of the distribution of returns can explain the low portfolio diversification. A simulation and calibration study is used to demonstrate the relevance of the theory and to disentangle the relative importance of the different effects.

Suggested Citation

  • Hyung, Namwon & de Vries, Casper G., 2012. "Simulating and calibrating diversification against black swans," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1162-1175.
    • Handle: RePEc:eee:dyncon:v:36:y:2012:i:8:p:1162-1175
    DOI: 10.1016/j.jedc.2012.03.007
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    References listed on IDEAS

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    Cited by:

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    2. Das, Sanjiv R. & Statman, Meir, 2013. "Options and structured products in behavioral portfolios," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 137-153.
    3. Alexeev, Vitali & Tapon, Francis, 2013. "Equity Portfolio Diversification: How Many Stocks are Enough? Evidence from Five Developed Markets," Working Papers 2013-16, University of Tasmania, Tasmanian School of Business and Economics, revised 20 Nov 2013.
    4. Vitali Alexeev & Francis Tapon, 2014. "The number of stocks in your portfolio should be larger than you think: diversification evidence from five developed markets," Published Paper Series 2014-4, Finance Discipline Group, UTS Business School, University of Technology, Sydney.

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    More about this item

    Keywords

    Portfolio diversification; Downside risk; Heavy tails; Calibration;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets
    • C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables
    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling

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