A Post-crisis Perspective on Diversification for Risk Management

Since the global financial crisis of 2008, improving risk management practices management of extreme risks, in particular—has been a hot topic.

Author(s):

Noel Amenc

Professor of finance, director of development at EDHEC Business School, and head of EDHEC-Risk Institute.

Felix Goltz

Head of applied research at EDHEC-Risk Institute and director of research and development at EDHEC-Risk Indices & Benchmarks.

Stoyan Stoyanov

Professor of finance at EDHEC Business School and programme director of the executive MSc in risk and investment management for Asia.

The postmodern quantitative techniques suggested as extensions of mean-variance analysis, however, exploit diversification as a general method. Although diversification is most effective in extracting risk premia over reasonably long investment horizons and is a key component of sound risk management, it is ill-suited for loss control in severe market downturns. Hedging and insurance are better suited for loss control over short horizons. In particular, dynamic asset allocation techniques deal efficiently with general loss constraints because they preserve access to the upside. Diversification is still very useful in these strategies, as the performance of well-diversified building blocks helps finance the cost of insurance strategies.

Type: EDHEC Publication
Date: le 06/05/2011
Research Cluster : Finance

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