Diversifying risk parity

Lohre, Harald; Opfer, Heiko; Ország, Gábor

doi:10.21314/jor.2014.284

Cited by 43 publications

(20 citation statements)

References 16 publications

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“…Of course, we could always optimize the problem (5) and consider the optimal solution without verifying that the objective function is equal to zero. In this case, we obtain the portfolio for which the risk contributions are the closest to the risk budgets in the sense of the L 2 absolute norm 13 . We consider now a related problem:…”

Section: Minimizing the Risk Concentration Between The Risk Factorsmentioning

confidence: 99%

Risk parity portfolios with risk factors

Roncalli

Weisang

2015

Quantitative Finance

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Portfolio construction and risk budgeting are the focus of many studies by academics and practitioners. In particular, diversification has spawn much interest and has been defined very differently. In this paper, we analyze a method to achieve portfolio diversification based on the decomposition of the portfolio's risk into risk factor contributions. First, we expose the relationship between risk factor and asset contributions. Secondly, we formulate the diversification problem in terms of risk factors as an optimization program. Finally, we illustrate our methodology with some real life examples and backtests, which are: budgeting the risk of Fama-French equity factors, maximizing the diversification of an hedge fund portfolio and building a strategic asset allocation based on economic factors.

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Section: Minimizing the Risk Concentration Between The Risk Factorsmentioning

confidence: 99%

Risk parity portfolios with risk factors

Roncalli

Weisang

2015

Quantitative Finance

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“…For example, over the 1972 to 1989 period, the minimum variance portfolio delivered equal or greater returns than a broad market cap-weighted index of U.S. stocks, while achieving lower volatility [6]. Lohre, Neugebauer and Zimmer [1] identify the existence of a large literature demonstrating minimum-variance strategies to be far more efficient than capitalization-weighted benchmarks. These surprising findings have been attributed to the high estimation risk associated with expected returns [7].…”

Section: Diversification Strategiesmentioning

confidence: 99%

“…Diversified Risk Parity, which is based on the work of Meucci [2] and Lohre et al [1], involves using principal components analysis (PCA) to identify the largest uncorrelated risk sources in the investment universe. The most diversified portfolio is the one which follows the risk parity approach and spreads risk evenly across these independent sources [10].…”

Section: Diversified Risk Paritymentioning

confidence: 99%

“…. ., and the columns of matrix E represent the eigenvectors of Σ [1]. These eigenvectors define a set of N uncorrelated principal portfolios with variance (λ 1 , .…”

Section: σ = Eλementioning

confidence: 99%

“…Lohre et al [1] define the Diversified Risk Parity (DRP) portfolio as the one whose risk parity weights maximize N Ent under a set of investment constraints (e.g. longonly investment, limited size portfolio, weight granularity).…”

Section: σ = Eλementioning

confidence: 99%

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Maximizing positive porfolio diversification

Maguire

Moser

O'Reilly

et al. 2014

2014 IEEE Conference on Computational Intelligence for Financial Engineering &Amp; Economics (CIFEr)

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Abstract-In this article we introduce a new strategy for optimal diversification which combines elements of Diversified Risk Parity [1], [2] and Diversification Ratio [3], with emphasis on positive risk premiums. The Uncorrelated Positive Bets strategy involves the identification of reliable, independent sources of randomness and the quantification of their positive risk premium. We use principal component analysis to identify the most significant sources of randomness contributing to the market and then apply the Randomness Deficiency Coefficient metric [4] and principal portfolio positivity to identify a set of reliable uncorrelated positive bets. Portfolios are then optimized by maximizing their diversified positive risk premium. We contrast the performance of a range of diversification strategies for a portfolio held for a two-year out-of-sample period with a 30 stock constraint. In particular, we introduce the notion of diversification inefficiency to explain why diversification strategies might outperform the market.

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