Return Gaps and Efficient Diversification


In a previous post, I showed how different asset classes correlate with one another and their effect on portfolio diversification. Meir Statman, Glenn Klimek professor of finance at Santa Clara University and a member of the Loring Ward Investment Committee, notes1 however, that return gaps between pairs of asset classes may be another way to measure their diversification benefit in a portfolio. Return gaps show the absolute value of the difference in cumulative returns between asset classes over a given time period. This measure considers not only correlation but the standard deviation2 of returns when determining the diversification benefits of an asset class. A look at return gaps against the S&P 500 over the 25-year-period from 1989 demonstrates the diversification benefits of various asset classes, with larger return gaps indicating more diversification benefit.
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What does the Herd Know?

I came across an article talking about how a recent bison stampede got some folks worried about a super volcano eruption in Yellowstone National Park. The person filming the stampede suggested that since animals have certain instincts, the stampede could be a sign that the massive caldera (super volcano) may be about to erupt, which would be disastrous.
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