This paper analyses whether the use of uncorrelated underlying risk factors, as opposed to correlated asset returns, can lead to a more efficient framework for measuring and managing portfolio diversification.
The paper, by academics at EDHEC Business School and SYMMYS, acknowledges that the ability to construct well-diversified portfolios is a challenge of critical importance in the context of designing good proxies for performance-seeking portfolios. It shows that a seemingly well-diversified allocation to asset classes may well result in a portfolio that is heavily concentrated in terms of factor exposures. In this context, it argues, it is of high relevance to measure and manage the effective number of bets in a portfolio.
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Risk Parity and Beyond – From Asset Allocation to Risk Allocation Decisions