The Diversification Delta: A Different Perspective

In a 2012 article published inThe Journal of Portfolio Management , Vermorken, Medda, and Schröder introduce a new measure of diversification, theDiversification Delta (DD ), based on the entropy of the portfolio return distribution. Entropy as a measure of uncertainty has been used successfully in...

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Bibliographic Details
Published in:Journal of portfolio management 2017-07, Vol.43 (4), p.112-124
Main Authors: Salazar Flores, Yuri, Bianchi, Robert J., Drew, Michael E., Trück, Stefan
Format: Article
Language:English
Subjects:
Business schools
Diversification
Econometrics
Economic models
Entropy
Generalized method of moments
Information theory
Optimization
Portfolio management
Random variables
Risk management
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Summary:In a 2012 article published inThe Journal of Portfolio Management , Vermorken, Medda, and Schröder introduce a new measure of diversification, theDiversification Delta (DD ), based on the entropy of the portfolio return distribution. Entropy as a measure of uncertainty has been used successfully in several frameworks and takes into account the entire statistical distribution, rather than just the first two moments. In this article, the authors highlight some drawbacks of theDD measure and go on to propose an alternative measure based on exponential entropy that overcomes the identified shortcomings. The authors present the properties of this new measure and propose it as an alternative for portfolio optimization that incorporates higher moments of asset returns, such as skewness and excess kurtosis.
ISSN:0095-4918
2168-8656
DOI:10.3905/jpm.2017.43.4.112