Practical Applications of An Index Methodology for Diversifying Business Risk

The practitioner companion to “An Index Methodology for Diversifying Business Risk,” this paper introduces a methodology for constructing an equity index in which the weight assigned to each component is determined by the nature of the business risks it carries, using statistical stratification to maximize diversification across categories of business risk.

Using the S&P 500 and S&P MidCap 400 as test populations, Riggs, Chandler, and Finn compare stratified indexes built on this methodology against market-capitalization-weighted and equal-weighted indexes of the same components, finding that the stratified indexes delivered both higher returns and higher Sharpe ratios.

Together with its companion paper, this is the empirical foundation for the functional coordinate system applied to portfolio construction — see Financial Markets.

Read the paper at pm-research.com →

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