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

Thierry Roncalli

Bankers, Markets & Investors, 2015, issue 138, 18-28

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.

Keywords: Risk parity; Risk budgeting; Expected returns; ERC portfolio; Value-at-risk; Expected shortfall; Active management; Tactical asset allocation; Strategic asset allocation (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2015
References: Add references at CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://www.revue-banque.fr/article/introducing-exp ... isk-parity-portfolio (text/html)
price

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:rbq:journl:i:138:p:18-28

Ordering information: This journal article can be ordered from
12 rue du Quatre-Septembre, 75002 PARIS France
http://www.eska.fr

Access Statistics for this article

More articles in Bankers, Markets & Investors from ESKA Publishing
Bibliographic data for series maintained by Marise Urbano ().