Asset and Factor Risk Budgeting: A Balanced Approach

Adil Rengim Cetingoz and Olivier Gu\'eant

Papers from arXiv.org

Abstract: Portfolio optimization methods have evolved significantly since Markowitz introduced the mean-variance framework in 1952. While the theoretical appeal of this approach is undeniable, its practical implementation poses important challenges, primarily revolving around the intricate task of estimating expected returns. As a result, practitioners and scholars have explored alternative methods that prioritize risk management and diversification. One such approach is Risk Budgeting, where portfolio risk is allocated among assets according to predefined risk budgets. The effectiveness of Risk Budgeting in achieving true diversification can, however, be questioned, given that asset returns are often influenced by a small number of risk factors. From this perspective, one question arises: is it possible to allocate risk at the factor level using the Risk Budgeting approach? First, we introduce a comprehensive framework to address this question by introducing risk measures directly associated with risk factor exposures and demonstrating the desirable mathematical properties of these risk measures, making them suitable for optimization. Then, we propose a novel framework to find portfolios that effectively balance the risk contributions from both assets and factors. Leveraging standard stochastic algorithms, our framework enables the use of a wide range of risk measures to construct diversified portfolios.

Date: 2023-12, Revised 2024-05
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://arxiv.org/pdf/2312.11132 Latest version (application/pdf)

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:arx:papers:2312.11132

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().