IDEAS home Printed from https://ideas.repec.org/p/arx/papers/1610.08818.html
   My bibliography  Save this paper

Agnostic Risk Parity: Taming Known and Unknown-Unknowns

Author

Listed:
  • Raphael Benichou
  • Yves Lemp'eri`ere
  • Emmanuel S'eri'e
  • Julien Kockelkoren
  • Philip Seager
  • Jean-Philippe Bouchaud
  • Marc Potters

Abstract

Markowitz' celebrated optimal portfolio theory generally fails to deliver out-of-sample diversification. In this note, we propose a new portfolio construction strategy based on symmetry arguments only, leading to "Eigenrisk Parity" portfolios that achieve equal realized risk on all the principal components of the covariance matrix. This holds true for any other definition of uncorrelated factors. We then specialize our general formula to the most agnostic case where the indicators of future returns are assumed to be uncorrelated and of equal variance. This "Agnostic Risk Parity" (AGP) portfolio minimizes unknown-unknown risks generated by over-optimistic hedging of the different bets. AGP is shown to fare quite well when applied to standard technical strategies such as trend following.

Suggested Citation

  • Raphael Benichou & Yves Lemp'eri`ere & Emmanuel S'eri'e & Julien Kockelkoren & Philip Seager & Jean-Philippe Bouchaud & Marc Potters, 2016. "Agnostic Risk Parity: Taming Known and Unknown-Unknowns," Papers 1610.08818, arXiv.org.
    • Handle: RePEc:arx:papers:1610.08818
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/1610.08818
    File Function: Latest version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Roncalli, Thierry, 2013. "Introduction to Risk Parity and Budgeting," MPRA Paper 47679, University Library of Munich, Germany.
    2. Jean-Philippe Bouchaud & Marc Potters & Jean-Pierre Aguilar, 1997. "Missing Information and Asset Allocation," Papers cond-mat/9707042, arXiv.org.
    3. Y. Lemp'eri`ere & C. Deremble & P. Seager & M. Potters & J. P. Bouchaud, 2014. "Two centuries of trend following," Papers 1404.3274, arXiv.org.
    4. repec:ebl:ecbull:v:7:y:2004:i:3:p:1-10 is not listed on IDEAS
    5. Frahm, Gabriel & Wiechers, Christof, 2011. "On the diversification of portfolios of risky assets," Discussion Papers in Econometrics and Statistics 2/11, University of Cologne, Institute of Econometrics and Statistics.
    6. M. Hossein Partovi & Michael Caputo, 2004. "Principal Portfolios: Recasting the Efficient Frontier," Economics Bulletin, AccessEcon, vol. 7(3), pages 1-10.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Andrew Butler & Roy H. Kwon, 2021. "Data-driven integration of norm-penalized mean-variance portfolios," Papers 2112.07016, arXiv.org, revised Nov 2022.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Benoît Carmichael & Gilles Boevi Koumou & Kevin Moran, 2023. "Unifying Portfolio Diversification Measures Using Rao’s Quadratic Entropy," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 21(4), pages 769-802, December.
    2. Gilles Boevi Koumou & Georges Dionne, 2022. "Coherent Diversification Measures in Portfolio Theory: An Axiomatic Foundation," Risks, MDPI, vol. 10(11), pages 1-19, October.
    3. Gianni Pola, 2016. "On entropy and portfolio diversification," Journal of Asset Management, Palgrave Macmillan, vol. 17(4), pages 218-228, July.
    4. Thorsten Poddig & Albina Unger, 2012. "On the robustness of risk-based asset allocations," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(3), pages 369-401, September.
    5. Tung-Lam Dao & Trung-Tu Nguyen & Cyril Deremble & Yves Lemp'eri`ere & Jean-Philippe Bouchaud & Marc Potters, 2016. "Tail protection for long investors: Trend convexity at work," Papers 1607.02410, arXiv.org.
    6. Gilles Boevi Koumou, 2020. "Diversification and portfolio theory: a review," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 34(3), pages 267-312, September.
    7. Lauren Stagnol, 2015. "Designing a corporate bond index on solvency criteria," EconomiX Working Papers 2015-39, University of Paris Nanterre, EconomiX.
    8. Vaughn Gambeta & Roy Kwon, 2020. "Risk Return Trade-Off in Relaxed Risk Parity Portfolio Optimization," JRFM, MDPI, vol. 13(10), pages 1-28, October.
    9. Frieder Meyer-Bullerdiek, 2017. "Rebalancing and Diversification Return – Evidence from the German Stock Market," Journal of Finance and Investment Analysis, SCIENPRESS Ltd, vol. 6(2), pages 1-1.
    10. L. Lin & M. Schatz & D. Sornette, 2019. "A simple mechanism for financial bubbles: time-varying momentum horizon," Quantitative Finance, Taylor & Francis Journals, vol. 19(6), pages 937-959, June.
    11. Zaremba, Adam & Bianchi, Robert J. & Mikutowski, Mateusz, 2021. "Long-run reversal in commodity returns: Insights from seven centuries of evidence," Journal of Banking & Finance, Elsevier, vol. 133(C).
    12. Kentaro Imajo & Kentaro Minami & Katsuya Ito & Kei Nakagawa, 2020. "Deep Portfolio Optimization via Distributional Prediction of Residual Factors," Papers 2012.07245, arXiv.org.
    13. da Costa, B. Freitas Paulo & Pesenti, Silvana M. & Targino, Rodrigo S., 2023. "Risk budgeting portfolios from simulations," European Journal of Operational Research, Elsevier, vol. 311(3), pages 1040-1056.
    14. Bernardo Freitas Paulo da Costa & Silvana M. Pesenti & Rodrigo S. Targino, 2023. "Risk Budgeting Portfolios from Simulations," Papers 2302.01196, arXiv.org.
    15. Y. Lemp'eri`ere & C. Deremble & T. T. Nguyen & P. Seager & M. Potters & J. P. Bouchaud, 2014. "Risk Premia: Asymmetric Tail Risks and Excess Returns," Papers 1409.7720, arXiv.org, revised Oct 2015.
    16. William Lefebvre & Gregoire Loeper & Huy^en Pham, 2020. "Mean-variance portfolio selection with tracking error penalization," Papers 2009.08214, arXiv.org, revised Sep 2020.
    17. Ahmed Belhadjayed & Grégoire Loeper & Frédéric Abergel, 2016. "Forecasting Trends With Asset Prices," Post-Print hal-01512431, HAL.
    18. Thierry Roncalli, 2018. "Keep up the momentum," Journal of Asset Management, Palgrave Macmillan, vol. 19(5), pages 351-361, September.
    19. Ben R. Craig & Margherita Giuzio & Sandra Paterlini, 2019. "The Effect of Possible EU Diversification Requirements on the Risk of Banks’ Sovereign Bond Portfolios," Working Papers 19-12, Federal Reserve Bank of Cleveland.
    20. Firoozye, Nikan & Tan, Vincent & Zohren, Stefan, 2023. "Canonical portfolios: Optimal asset and signal combination," Journal of Banking & Finance, Elsevier, vol. 154(C).

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:1610.08818. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: arXiv administrators (email available below). General contact details of provider: http://arxiv.org/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.