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Apr 21

Managing Diversification

Posted by abiao at 17:27 | Code » Matlab | Comments(0) | Reads(4654)
Needless to say, diversification plays a pivotal role in investment, not only for risk management, but for return generation. Attilio Meucci and his colleagues have another wonderful paper on managing diversification:
We propose a unified, fully general methodology to analyze and act on diversification in any environment, including long-short trades in highly correlated markets. First, we build the diversification distribution, i.e. the distribution of the uncorrelated bets in the portfolio that are consistent with the portfolio constraints. Next, we summarize the wealth of information provided by the diversification distribution into one single diversification index, the effective number of bets, based on the entropy of the diversification distribution. Then, we introduce the mean-diversification efficient frontier, a diversification approach to portfolio optimization. Finally, we describe how to perform mean-diversification optimization in practice in the presence of transaction and market impact costs, by only trading a few optimally chosen securities.

Click for codes http://www.mathworks.com/matlabcentral/fileexchange/23271

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