On a Class of Diverse Market Models

TL;DR

This paper introduces a new class of market models in Stochastic Portfolio Theory that combines the properties of diversity and the larger drift of smaller stocks, providing conditions for their diversity.

Contribution

It develops a novel class of market models that incorporate both diversity and the larger drift of small stocks, with testable conditions for diversity.

Findings

Derived simple conditions for market diversity.

Established conditions under which markets are not diverse.

Enhanced modeling of real-world market features.

Abstract

A market model in Stochastic Portfolio Theory is a finite system of strictly positive stochastic processes. Each process represents the capitalization of a certain stock. If at any time no stock dominates almost the entire market, which means that its share of total market capitalization is not very close to one, then the market is called diverse. There are several ways to outperform diverse markets and get an arbitrage opportunity, and this makes these markets interesting. A feature of real-world markets is that stocks with smaller capitalizations have larger drift coefficients. Some models, like the Volatility-Stabilized Model, try to capture this property, but they are not diverse. In an attempt to combine this feature with diversity, we construct a new class of market models. We find simple, easy-to-test sufficient conditions for them to be diverse and other sufficient conditions for them not to be diverse.