Improved Risk Reporting with Factor-Based Diversification Measures

Improved Risk Reporting with Factor-Based Diversification Measures — February 2014

Executive Summary

We compare the annualised performances of the selected equity indices over the period starting at the beginning of September 2008 and ending at the end of February 2009, and their average diversification measures computed across six different periods. The average diversification measures are computed on periods immediately preceding the calculation of the index performance. 4

In Figure 1, we plot the annualised performances of the 14 equity indices between September 2008 and February 2009 with respect to each diversification measure computed at the date immediately preceding the bear market period at the end of August 2008. We perform linear regressions in order to test the robustness of the relationship between performance and diversification

Figure 1: Performances of 14 Equity Indices with respect to their Diversification Measures during the Subprime Crisis These figures display the annualised performances of 14 equity indices during the worst of the subprime crisis (between the beginning of September 2008 and the end of February 2009) with respect to their respective effective number of constituents (ENC) and their effective number of uncorrelated bets (ENB) computed at the end of August 2008. These figures display the outlier (the FTSE 100), but the slope of the linear regression is computed without this outlier.

4 - These periods being at the end of August 2008, during August 2008, during the quarter preceding September 2008, during the semester preceding September 2008, during the year starting on September 2007 and ending at the end of August 2008 and during the two-year period starting on September 2006 and ending at the end of August 2008.

10

An EDHEC-Risk Institute Publication