Managing diversification

The qualitative definition of diversification is very clear to portfolio managers: a portfolio is well diversified if it is not heavily exposed to individual shocks. However, oddly enough, there exists no broadly accepted, unique, satisfactory methodology to precisely quantify and manage diversification.

In the special case of systematic-plus-idiosyncratic factor models, diversification is measured as the percentage of risk explained by the systematic factors. However, 'idiosyncratic' shocks are