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Taking the right course navigating the ERC universe

Author

Listed:
  • Roberto Savona

    (University of Brescia)

  • Cesare Orsini

    (Epsilon Associati Sgr S.p.A)

Abstract

We study the equal risk contribution (ERC) investment strategies exploring how these portfolios perform relative to traditional risk-only (minimum variance portfolio), risk–return (Markowitz portfolio) and naïve (1/n) investment schemes when expanding the asset class universe. We propose a combinatorial mechanism to expand the investment universe of all feasible ERC portfolios and then combine them, thus realizing an ERC efficient frontier consistent with the mutual fund separation theorem (Merton in J Financ Quant Anal 7:1851–1872, 1972). In doing this, we mitigate the out-of-sample estimation error in portfolio weights and better diversify asset allocation against unpredictable extreme events. Simulation, bootstrapping and empirical experiments indicate that the corresponding tangency portfolio, computed through the regression-based approach introduced in Britten-Jones (J Finance 54:655–671, 1999), offers better risk-adjusted performance relative to risk-only, risk–return-based competitors as well as the 1/n strategy.

Suggested Citation

  • Roberto Savona & Cesare Orsini, 2019. "Taking the right course navigating the ERC universe," Journal of Asset Management, Palgrave Macmillan, vol. 20(3), pages 157-174, May.
    • Handle: RePEc:pal:assmgt:v:20:y:2019:i:3:d:10.1057_s41260-019-00117-5
    DOI: 10.1057/s41260-019-00117-5
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    References listed on IDEAS

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    1. Sébastien Laurent & Jeroen V. K. Rombouts & Francesco Violante, 2012. "On the forecasting accuracy of multivariate GARCH models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 27(6), pages 934-955, September.
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    Cited by:

    1. Charles-Albert Lehalle & Guillaume Simon, 2021. "Portfolio selection with active strategies: how long only constraints shape convictions," Journal of Asset Management, Palgrave Macmillan, vol. 22(6), pages 443-463, October.

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    More about this item

    Keywords

    Portfolio optimization; Risk parity; Equal risk contribution;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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