Optimal Risk Budgeting under a Finite Investment Horizon

Marcos López de Prado, Ralph Vince and Qiji Jim Zhu
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Marcos López de Prado: Lawrence Berkeley National Laboratory, Berkeley, CA 94720, USA
Ralph Vince: Vince Strategies, LLC, The Chrysler Building, 405 Lexington Ave 26th fl., New York, NY 10174, USA
Qiji Jim Zhu: Department of Mathematics, Western Michigan University, 1903 West Michigan Avenue, Kalamazoo, MI 49008, USA

Risks, 2019, vol. 7, issue 3, 1-15

Abstract: The Growth-Optimal Portfolio (GOP) theory determines the path of bet sizes that maximize long-term wealth. This multi-horizon goal makes it more appealing among practitioners than myopic approaches, like Markowitz’s mean-variance or risk parity. The GOP literature typically considers risk-neutral investors with an infinite investment horizon. In this paper, we compute the optimal bet sizes in the more realistic setting of risk-averse investors with finite investment horizons. We find that, under this more realistic setting, the optimal bet sizes are considerably smaller than previously suggested by the GOP literature. We also develop quantitative methods for determining the risk-adjusted growth allocations (or risk budgeting) for a given finite investment horizon.

Keywords: Growth-optimal portfolio; risk management; Kelly criterion; finite investment horizon; drawdown (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2019
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