IDEAS home Printed from https://ideas.repec.org/a/rbq/journl/i138p18-28.html
   My bibliography  Save this article

Introducing Expected Returns into Risk Parity Portfolios: A New Framework for Asset Allocation

Author

Listed:
  • Thierry Roncalli

    (Lyxor Asset Management, University of Evry)

Abstract

Risk parity is an allocation method used to build diversified portfolios that does not rely on any assumptions of expected returns, thus placing risk management at the heart of the strategy. This explains why risk parity became a popular investment model after the global financial crisis in 2008. However, risk parity has also been criticized because it focuses on managing risk concentration rather than portfolio performance, and is therefore seen as being closer to passive management than active management. In this article, we show how to introduce assumptions of expected returns into risk parity portfolios. To do this, we consider a generalized risk measure that takes into account both the portfolio return and volatility. However, the trade-off between performance and volatility contributions creates some difficulty, while the risk budgeting problem must be clearly defined. After deriving the theoretical properties of such risk budgeting portfolios, we apply this new model to asset allocation. First, we compare risk budgeting portfolios and optimized portfolios and illustrate that the new approach defines a defensive model of active management. Then, we consider long-term investment policy and the determination of strategic asset allocation.

Suggested Citation

  • Thierry Roncalli, 2015. "Introducing Expected Returns into Risk Parity Portfolios: A New Framework for Asset Allocation," Bankers, Markets & Investors, ESKA Publishing, issue 138, pages 18-28, September.
  • Handle: RePEc:rbq:journl:i:138:p:18-28
    as

    Download full text from publisher

    File URL: http://www.revue-banque.fr/article/introducing-expected-returns-risk-parity-portfolio
    Download Restriction: price

    Citations

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


    Cited by:

    1. Jean-Charles Richard & Thierry Roncalli, 2019. "Constrained Risk Budgeting Portfolios: Theory, Algorithms, Applications & Puzzles," Papers 1902.05710, arXiv.org.

    More about this item

    Keywords

    Risk parity; Risk budgeting; Expected returns; ERC portfolio; Value-at-risk; Expected shortfall; Active management; Tactical asset allocation; Strategic asset allocation;

    JEL classification:

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

    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:rbq:journl:i:138:p:18-28. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marise Urbano). General contact details of provider: http://www.eska.fr/ .

    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.

    We have no references for this item. You can help adding them by using 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.

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

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.