Dispersion: Measuring Market Opportunity

10 Feb 2015

Article by: Tim Edwards PhD, Craig J. Lazzara CFA
Published by: McGraw Hill Financial
Date: Dec 2013

“With apologies to Jane Austen, it is a truth universally acknowledged that a portfolio manager in control of a fortune must be in want of diversification. But what does it mean to say that a particular index (or portfolio) is diversified? Or more diversified than another, or more now than it was before? In order to speak meaningfully about the internal diversity of an index and its variation over time, quantitative metrics are required. The most commonly encountered is the correlation statistic, but correlations contain critical and unavoidable flaws. It turns out that another measure—asset dispersion—has strong qualifications as a complementary tool.

“In what follows, we’ll show how dispersion can be used to examine the connection between active management performance and the idiosyncrasies present within underlying markets. We’ll also demonstrate other interesting uses of dispersion, which is well-suited to address questions regarding the importance of various risk factors and exposures.”

Full article (PDF): Link

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