Other Definitions
diversification (dict)
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DiversificationDiversification is a measure of the commonality of a population. Greater diversification denotes a wider variety of elements within that population. Diversification is of central importance in investments. Diversification reduces the risk of a portfolio. It does not necessarily reduce the returns. This is why diversification is referred to as the only free lunch in finance. Diversification can be quantified as the intra-portfolio correlation. This is a statistical measurement from negative one to one that measures the degree to which the various assets in a portfolio can be expected to perform in a similar fashion. | Intra-portfolio correlation | Percent of diversifiable risk eliminated | | 1 | 0% | | .75 | 12.5% | | .50 | 25% | | .25 | 37.5% | | 0 | 50% | | -.25 | 62.5% | | -.50 | 75% | | -.75 | 87.5% | | -1 | 100% | Portfolio balance occurs as the sum of all intra-portfolio correlations approaches negative one. Diversification is thus defined as the intra-portfolio correlation or, more specifically, the weighted average intra-portfolio correlation. Maximum diversification occurs when the intra-portfolio correlation is minimized. Intra-portfolio correlation may be an effective risk management measurement. The computation may be expressed as: -
Q = \frac{\sum_{i=1}^n\sum_{j=1}^n X_i X_j P_{ij}}{\sum_{i=1}^n\sum_{j=1}^n X_i X_j} Where Q is the intra-portfolio correlation, is the fraction invested in asset i, is the fraction invested in asset j, is the correlation between assets i and j, and n is the number of different assets. See also *List of finance topics
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