The University of Illinois at Urbana-Champaign; Diversification return is an incremental return earned by a rebalanced portfolio of assets. The author argues that the underlying source of the diversification return is the rebalancing; in contrast, the incremental return of a buy-and-hold portfolio is driven by the fact that the best-performing assets become a greater fraction of the portfolio. On the basis of these findings, the author resolves two aspects of a puzzle associated with Gorton and Rouwenhorst's index of commodity futures.
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