Template-Type: ReDIF-Paper 1.0 Series: Tinbergen Institute Discussion Papers Creation-Date: 2005-01-17 Revision-Date: 2006-10-04 Number: 05-009/2 Author-Name: Namwon Hyung Author-Workplace-Name: Seoul City University Author-Name: Casper G. de Vries Author-Email: email@example.com Author-Workplace-Name: Erasmus School of Economics, Erasmus Universiteit Rotterdam Title: Portfolio Selection with Heavy Tails Abstract: Consider the portfolio problem of choosing the mix between stocks and bonds under a downside risk constraint. Typically stock returns exhibit fatter tails than bonds corresponding to their greater downside risk. Downside risk criteria like the safety first criterion therefore often select corner solutions in the sense of a bonds only portfolio. This is due to a focus on the asymptotically dominating first order Pareto term of the portfolio return distribution. We show that if second order terms are taken into account, a balanced solution emerges. The theory is applied to empirical examples from the literature.
This discussion paper has resulted in a publication in the Journal of Empirical Finance, 2007, 14(3). Classification-JEL: G11 Keywords: safety first; heavy tails; portfolio diversification File-Url: http://papers.tinbergen.nl/05009.pdf File-Format: application/pdf File-Size: 316924 bytes Handle: RePEc:tin:wpaper:20050009