Risk Parity Portfolios with Risk Factors
AbstractPortfolio construction and risk budgeting are the focus of many studies by academics and practitioners. In particular, diversification has spawn much interest and has been defined very differently. In this paper, we analyze a method to achieve portfolio diversification based on the decomposition of the portfolio's risk into risk factor contributions. First, we expose the relationship between risk factor and asset contributions. Secondly, we formulate the diversification problem in terms of risk factors as an optimization program. Finally, we illustrate our methodology with some real life examples and backtests, which are: budgeting the risk of Fama-French equity factors, maximizing the diversification of an hedge fund portfolio and building a strategic asset allocation based on economic factors.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 44017.
Date of creation: 15 Sep 2012
Date of revision:
risk parity; risk budgeting; factor model; ERC portfolio; \diversification; concentration; Fama-French model; hedge fund allocation; strategic asset allocation;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
- C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
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- Bruder, Benjamin & Roncalli, Thierry, 2012. "Managing risk exposures using the risk budgeting approach," MPRA Paper 37246, University Library of Munich, Germany.
- Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
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