Managing risk exposures using the risk budgeting approach

Benjamin Bruder and Thierry Roncalli

MPRA Paper from University Library of Munich, Germany

Abstract: The ongoing economic crisis has profoundly changed the industry of the asset management, by putting risk management at the heart of most investment processes. This new risk-based investment style does not rely on returns forecasts and is therefore assumed to be more robust. In 2011, it has particularly encountered a great success with the achievement of minimum variance, ERC and risk parity strategies in portfolios of several large institutional investors. These portfolio constructions are special cases of a more general class of allocation models, known as the risk budgeting approach. In a risk budgeting portfolio, the risk contribution from each component is equal to the budget of risk defined by the portfolio manager. Unfortunately, even if risk budgeting techniques are widely used by market practitioners, they are few results about the behavior of such portfolios in the academic literature. In this paper, we derive the theoretical properties of the risk budgeting portfolio and show that its volatility is located between those of minimum variance and weight budgeting portfolios. We also discuss the existence, uniqueness and optimality of such a portfolio. In a second part of the paper, we propose several applications of risk budgeting techniques for risk-based allocation, like risk parity funds and strategic asset allocation, and equity and bond alternative indexations.

Keywords: Risk budgeting; risk management; risk-based allocation; equal risk contribution; diversification; concentration; risk parity; alternative indexation; strategic asset allocation (search for similar items in EconPapers)
JEL-codes: C60 G11 (search for similar items in EconPapers)
Date: 2012-01
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (29)

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https://mpra.ub.uni-muenchen.de/37749/2/MPRA_paper_37749.pdf revised version (application/pdf)

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