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Un-diversifying during crises: is it a good idea?

17 October 2018 at 12:00 PM - 1:30 PM

Room 207, Campus on Viale Romania 32

Speaker: Giuzio Margherita, ECB

Abstract: High levels of correlation among financial assets and extreme losses are typical during crises. In such
situations, investing in few assets might be a better choice than holding diversified portfolios. We show that
constraining the sparse `q-norm of portfolio weights automatically controls diversification and selects portfolios
with a small number of active weights and low risk, in presence of high correlation and volatility. We high
light the diversification relationships between the minimum variance portfolio, risk budgeting strategies and
diversification-constrained portfolios. Finally, we show empirically that the `q-strategy can successfully cope
with bear markets by shrinking portfolio weights and total amount of shorting.