Equally Diversified or Equally Weighted?

Fusai, G. ORCID: 0000-0001-9215-2586, Mignacca, D., Human, B. & Nardon, A. (2020). Equally Diversified or Equally Weighted?. Risk Magazine,

Abstract

We show how to decompose the portfolio volatility into undiversified volatility and diversification components. Our decomp osition has a clear statistical interpretation because it relates the diversification component to the partial covariances,i.e.the covariances between the residuals of the regressions of the weighted asset returns with respect to the portfolio return. On this basis, we advocate the construction of an equally diversified p ortfolio. An empirical analysis illustrates the superior out-of-sample performance of the equally diversified portfolios with respect to the equally weighted portfolio.