Downside risk portfolio diversification effects

Risk managers use portfolios to diversify away the unpriced risk of individual securities.In this paper we compare the beneÞts of portfolio diversiÞcation for downside risk with the variance.The risk of a security is decomposed into a part which is attributable to the market risk and an orthogonal risk factor.The orthogonal part consists of an idiosyncratic part and a part which is attributable to dependency between assets, but which cannot be explained by the market risk.We Þnd that the idiosyncratic downside risk evaporates more rapidly than the idiosyncratic variance risk.For this we offer a theoretical explanation on basis of the heavy tail properties of the asset return distributions.We also Þnd that the non-diversiÞable non-market factors are more important for the downside risk than for the global risk measure.