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What is a good investment metric to reward diversification within a portfolio. Suppose we have a fixed income universe and prefer stable currency, mid yield and mid tenors. Our stressed spread var covar matrix suggests that we have correlation factor amongst each currency & fixed income class.

A simple metric would be weighted-portfolio for correlation Possibly the HHI Herfindahl index weights

This is in the context of Solvency II but would apply much more broadly. Any suggestions or solutions?

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This extends to not just FI but multi asset class (MAC) as well. You can use a linear MAC factor model to compute specific\unsystematic risk.

Here's are several examples of such a model:

You would compute specific risk the same way you normally would: How to calculate unsystematic risk?

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  • $\begingroup$ The second link seems to be broken. I would appreciate if you could post a working link. $\endgroup$ – AK88 Apr 19 '17 at 4:54
  • $\begingroup$ @AK88 thanks, second link should be fixed now. $\endgroup$ – pyCthon Apr 19 '17 at 21:20
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Also intrested in this question. A more qualitative approch is presented here.

Can you tell how did you get your variance-covariance matrix? Did you use daily price changes?

Somebody suggested using VaR if you have multi-currency FI portfolio. So you'd have VaR measures for specific bonds and for overall portfolio. And from there maybe you be able to see the difersification effect?

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  • $\begingroup$ Generally a comparison (i.e. ratio) of the overall risk(s) of the portfolio to the average risk(s) of the securities within it can be used as a measure of diversification. "Risk" can be std. dev, VaR, other... . See "diversification ratio". $\endgroup$ – noob2 Oct 20 '16 at 14:51
  • $\begingroup$ Thanks, not looking to diversify risk (e.g. on a variance based approach) but reward broad allocation. $\endgroup$ – rrg Oct 22 '16 at 15:01
  • $\begingroup$ @ AK88 covar matrix on monthly $\endgroup$ – rrg Dec 22 '16 at 12:24

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