Managing Sovereign Credit Risk in Bond Portfolios

Bruder, Benjamin; Hereil, Pierre; Roncalli, Thierry

doi:10.2478/v10259-012-0001-3

Cited by 3 publications

(3 citation statements)

References 26 publications

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“…The beta β i of the asset i with respect to the portfolio x is then defined as the ratio between the covariance term (Σx) i and the variance x Σx of the portfolio. β i indicates the sensitivity of the asset i to the 9 The proof is provided in Appendix A.1. 10 Let x i (ρ) be the weight of the asset i in the RB portfolio when the constant correlation is equal to ρ.…”

Section: The General Case (N > 2)mentioning

confidence: 99%

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Managing Risk Exposures Using the Risk Budgeting Approach

Bruder¹,

Roncalli

2012

SSRN Journal

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The ongoing economic crisis has profoundly changed the industry of asset management by putting risk management at the heart of most investment processes. This new risk-based investment style does not rely on return forecasts and is therefore assumed to be more robust. 2011 was marked by several great successes in transforming the practice of asset management with several large institutional investors moving their portfolios to minimum variance, ERC or risk parity strategies. These portfolio constructions are special cases of a more general class of allocation models, known as the risk budgeting approach. In a risk budgeting portfolio, the risk contribution from each component is equal to the budget of risk defined by the portfolio manager. Unfortunately, even if risk budgeting techniques are widely used by market practitioners, there are few results about the behavior of such portfolios in the academic literature. In this paper, we derive the theoretical properties of the risk budgeting portfolio and show that its volatility is located between those of the minimum variance and weight budgeting portfolios. We also discuss the existence, uniqueness and optimality of such a portfolio. In the second part of the paper, we propose several applications of risk budgeting techniques for risk-based allocation, like risk parity funds and strategic asset allocation, and equity and bond alternative indexations.

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Section: The General Case (N > 2)mentioning

confidence: 99%

“…We consider a universe of nine asset classes : US Bonds 10Y (1), EURO Bonds 10Y (2), Investment Grade Bonds (3), High Yield Bonds (4), US Equities (5), Euro Equities (6), Japan Equities (7), EM Equities (8) and Commodities (9). In Table 7, we indicate the long-run statistics used to compute the strategic asset allocation 22 .…”

Section: Strategic Asset Allocationmentioning

confidence: 99%

Managing Risk Exposures Using the Risk Budgeting Approach

Bruder¹,

Roncalli

2012

SSRN Journal

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“…4 Such a simple risk estimate was chosen for expositional purposes and also because of the short horizon. More accurate estimates of long-term bond risk can be constructed using the bond duration and potentially also the volatility of credit default swaps, as in Bruder et al (2011). Constant-proportion portfolio insurance (CPPI) and option-based portfolio insurance (OBPI) are examples of strategies that sell stocks as the market falls and buy stocks as the market rises.…”

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confidence: 99%

Dynamic Risk-Based Asset Allocation

Boudt¹,

Darras

Peeters

2013

Wilmott

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In asset allocation, the equal risk contribution (ERC) approach has rapidly gained popularity: portfolio weights are dynamically set such that the asset classes contribute equally to the portfolio risk. As such, the portfolio loads automatically less on the more risky asset and, by diversifying across asset classes, portfolio drawdowns are reduced. When the equity subportfolio is allocated based on market capitalization weights, the ERC portfolio allocation tends to be dominated by the bond allocation. While the resulting portfolio has a low risk, it is -in today's market regime of low interest rates -also characterized by only moderate expected returns. For this reason, American fund managers have advocated to overlay the ERC portfolio with leverage. Such a leveraged risk-diversified portfolio is commonly referred to as a risk-parity strategy. This paper explores two leverage-free alternatives to increase tactically the equity allocation and preserve a completely risk-based asset allocation approach, which dynamically adjusts to the changing risk regimes. The first one consists of replacing the market capitalization-weighted equity index with a low-risk equity index. The second suggestion to increase the equity allocation is to deviate from an equal risk contribution objective to a 60/40 risk allocation strategy. We show that these two modifications increase significantly the weight of the equity portion in the portfolio, while still keeping the total risk of the dynamically rebalanced portfolios at a low level.

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The Risk Parity Principle Applied on a Corporate Bond Index Using Duration Times Spread

Stagnol¹

2016

SSRN Journal

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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 Times Spread (DTS) and demonstrate that it is a 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 riskadjusted performance enhancements. More generally, the ERC application we present seems to be a valuable trade-off between heuristic and more complex risk-modeling based weighting schemes.

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Managing Sovereign Credit Risk in Bond Portfolios

Cited by 3 publications

References 26 publications

Managing Risk Exposures Using the Risk Budgeting Approach

Managing Risk Exposures Using the Risk Budgeting Approach

Dynamic Risk-Based Asset Allocation

The Risk Parity Principle Applied on a Corporate Bond Index Using Duration Times Spread

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