Diversification Ratio

CFA Level I Portfolio Management
#1

Hi all,

I am a bit confused about the diversification ratio (DR) as it is defined in the Schweser Notes and what I have found in the literature.

Schweser notes defines the DR “as the ratio of the risk of an equally weighted portfolio of n securities to the risk of a single security selected at random from the n securities.

In the literature I have found that DR is “the ratio of the standard deviation of a equally weighted portfolio of n securities to the standard deviation of the portfolio”.

The problem is that I think that these two definition are not coherent because doing a Schweser notes’ mock exam I found out that a lower diversification ratio means that the portfolio is more diversified, but if I take the second definition of the DR mentioned above, a more diversified portfolio is one with the highest DR (because the denominator i.e. standard deviation of the portfolio is smaller than the standard deviation of the equally weighted portfolio of n securities, where it is assumed that the asset have a correlation of 1).

Could anyone help me? Thank you in advance!

#2

I believe diversification ratio is dividing the StDev of equally weighted portfolio by a random security.

1 Like
#3

But what’s about for example this definition here below:

http://allaboutalpha.com/blog/2011/03/27/the-most-diversified-portfolio/

It makes sense and is the only definition I can find on the net…

I don’t understand these different definitions and different results for the same ratio

#4

I dont disagree with you, that seems to be another option to measure diversification. From what I recall taking L1 in June, and from a link such as this: is that for the purposes of the CFA program currently it is using the way I described above. The CFA does change things from time to time though. here is a link for support:

http://analystnotes.com/cfa-study-notes-describe-the-portfolio-approach-to-investing.html

#5

Thank you for your reply, ok I will take it how it is defined by the CFA (although it make less sense to me).