Publication: The impact of heavy tails and comovements in downside-risk diversification
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2007-02-08
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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.
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Comovements, Copulas, Downside-risk diversification, Expected shortfall, Heavy tails, Lower partial moments, Shortfall probability