A Portfolio Diversification Index as a Fund Management Instrument : a Case of Johannesburg Stock Exchange
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Date
2008-08-16
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Abstract
Diversification is a basic tenet of portfolio construction but the conventional methods of measuring diversification remain inexact. Traditionally, a portfolio's diversification is measured relative to a market index. This approach is problematic in concentrated markets such as the JSE as the benchmark itself is often highly concentrated. A high level of concentration results in low diversification.
This report investigates a new quantitative measure of diversification called the portfolio diversification index (ibDI). The PDI is based on a number of independent factors which are quantified using Principal Component Analysis (PCA). The report shows:
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1. The diversification of various JSE market indices calculated using the PDI and illustrates the effect of concentration on diversification.
2. The use of the PDI as a tool to assist active fund managers to improve their Information Ratio.
Concentration is a major factor in smaller markets and this report highlights the dangers of simply transporting international research into other markets without first verifying the results.
Description
A thesis submitted to College of Art and Social Sciences, School of Business, 2008