Coherent Diversification Measures in Portfolio Theory: An Axiomatic Foundation
Risks 2022, 10(11), 205; https://doi.org/10.3390/risks10110205
19 Pages Posted: 21 Sep 2016 Last revised: 5 Jan 2023
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Coherent Diversification Measures in Portfolio Theory: An Axiomatic Foundation
Date Written: August 26, 2016
Abstract
We provide an axiomatic foundation for the measurement of correlation diversification in a one-period portfolio model. We propose a set of eight desirable axioms for this class of diversification measures. We name the measures satisfying these axioms coherent correlation diversification measures. We study the compatibility of our axioms with rank-dependent expected utility theory. We also test them against the two most frequently used methods for measuring correlation diversification in portfolio theory: portfolio variance and the diversification ratio. Lastly, we provide an example of a functional representation of a coherent correlation diversification measure.
Keywords: portfolio theory; diversification measurement; correlation diversification, diversification ratio; portfolio variance; rank-dependent expected utility theory
JEL Classification: D81, G1, G11
Suggested Citation: Suggested Citation