Improved Risk Reporting with Factor-Based Diversification Measures

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

3. Empirical Analysis for Equity Indices

and ended at the end of February 2010. Figure 8 shows that the linear relationship between diversification measures and performances is now negative for both the ENC and the ENB. This is confirmed in Table 5, where we look at the same period to estimate the performance during a bull market period, but where instead of looking at the diversification measure at one particular date (end of February 2009), we look at diversification measures over several extending windows (previous month, previous, quarter, previous semester, previous year and previous two years). In most regressions, we observe low p-value, which tend to confirm the negative slope with a reasonable level of confidence. This shows that, during the recovery of the subprime crisis (bull market), indices with lower levels of diversification performed better than indices with higher levels of diversification (both weight and factor based). This can be explained by the fact that when an equity index loads on more uncorrelated factors it may not increase as quickly as when the equity portfolio shows a more pronounced concentration. The stock index with the highest performance could be a portfolio fully concentrated in the best performing stock.

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An EDHEC-Risk Institute Publication