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The Risk Parity Principle applied on a Corporate Bond Index using Duration Times Spread

Lauren Stagnol ()

No 2016-27, EconomiX Working Papers from University of Paris Nanterre, EconomiX

Abstract: In this paper, we apply the principle of Equal Risk Contribution (ERC) to a corporate bond index, an asset class so far left behind in this literature. Specifically, we rely on the Duration Time Spread (DTS) and demonstrate that it is an coherent metric for bond risk. We construct indexes based on sector - issuer - and bond level using structured block correlation matrices, weights being inversely proportional to DTS. Our results provide evidence that applying ERC using DTS in the index design significantly improves corporate bond index risk-adjusted returns. It appears that the higher the granularity is, the higher will be the risk adjusted performance enhancements. More generally, the ERC application we present appears to be a valuable trade-off between heuristic and more complex risk-modeling based weighting schemes.

Keywords: Equal Risk Contribution; Risk Parity; Smart Beta; Risk Measure; Risk-Based Indexing; Alternative Corporate Bond Index. (search for similar items in EconPapers)
JEL-codes: C60 G10 G11 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2016
New Economics Papers: this item is included in nep-ore, nep-rmg and nep-sog
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