Diversification effects between stock indices
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Date
2010-12-01
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Abstract
During the World Financial Crisis it became obvious that classical models of portfolio
theory significantly under-estimated risks, especially with regard to stocks. Instabilities of correlations and volatilities, the relevant parameters characterizing risk, led to overestimation
of diversification effects and consequently to under-estimation of risks. In this
article, we analyze diversification effects concerning stocks during different market periods of the previous decade. We show that parameters and risks significantly change with market
periods and find that the impact of
fluctuations and estimation errors is 5 times larger for
volatilities than for correlations. Moreover, it turns out that diversification between sectors
is more efficient than diversification between countries.
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Keywords
Model Evaluation, Portfolio Optimization, Risk Management