Risk budget portfolios with convex Non-negative Matrix Factorization

Bruno Spilak and Wolfgang Karl H\"ardle

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Abstract: We propose a portfolio allocation method based on risk factor budgeting using convex Nonnegative Matrix Factorization (NMF). Unlike classical factor analysis, PCA, or ICA, NMF ensures positive factor loadings to obtain interpretable long-only portfolios. As the NMF factors represent separate sources of risk, they have a quasi-diagonal correlation matrix, promoting diversified portfolio allocations. We evaluate our method in the context of volatility targeting on two long-only global portfolios of cryptocurrencies and traditional assets. Our method outperforms classical portfolio allocations regarding diversification and presents a better risk profile than hierarchical risk parity (HRP). We assess the robustness of our findings using Monte Carlo simulation.

Date: 2022-04, Revised 2023-06
New Economics Papers: this item is included in nep-big, nep-cmp and nep-rmg
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