Bruder, Benjamin and Roncalli, Thierry (2012): Managing risk exposures using the risk budgeting approach.
This is the latest version of this item.

PDF
MPRA_paper_37749.pdf Download (1MB)  Preview 
Abstract
The ongoing economic crisis has profoundly changed the industry of the asset management, by putting risk management at the heart of most investment processes. This new riskbased investment style does not rely on returns forecasts and is therefore assumed to be more robust. In 2011, it has particularly encountered a great success with the achievement of minimum variance, ERC and risk parity strategies in portfolios of several large institutional investors. 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, they 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 minimum variance and weight budgeting portfolios. We also discuss the existence, uniqueness and optimality of such a portfolio. In a second part of the paper, we propose several applications of risk budgeting techniques for riskbased allocation, like risk parity funds and strategic asset allocation, and equity and bond alternative indexations.
Item Type:  MPRA Paper 

Original Title:  Managing risk exposures using the risk budgeting approach 
Language:  English 
Keywords:  Risk budgeting, risk management, riskbased allocation, equal risk contribution, diversification, concentration, risk parity, alternative indexation, strategic asset allocation 
Subjects:  G  Financial Economics > G1  General Financial Markets > G11  Portfolio Choice ; Investment Decisions C  Mathematical and Quantitative Methods > C6  Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C60  General 
Item ID:  37749 
Depositing User:  Thierry Roncalli 
Date Deposited:  30. Mar 2012 12:33 
Last Modified:  08. Sep 2015 14:01 
References:  Arnott, R., Hsu J. and Moore P. (2005), Fundamental indexation, Financial Analysts Journal, 61(2), pp. 8399 Artzner A., Delbaen F., Eber J.M. and Heath D. (1999), Coherent Measures of Risk, Mathematical Finance, 9(3), pp. 203228. Asness C.S., Frazzini A. and Pedersen L.H. (2012), Leverage Aversion and Risk Parity, Financial Analysts Journal, 68(1), pp. 4759. Berkelaar A.B., Kobor A. and Tsumagari M. (2006), The Sense and Nonsense of Risk Budgeting, Financial Analysts Journal, 62(5), pp. 6375. BajeuxBesnainou I., Jordan J.V. and Portait R. (2003), Dynamic Asset Allocation for Stocks, Bonds, and Cash, Journal of Business, 76(2), pp. 263287. Booth D. and Fama E. (1992), Diversification and Asset Contributions, Financial Analyst Journal, 48(3), pp. 2632. Boston Consulting Group (2011), Building on Success, Global Asset Management Report, www.bcg.com. Bruder B., Hereil P. and Roncalli T. (2011), Managing Sovereign Credit Risk, Journal of Indexes Europe, 1(4), pp. 2027. Bruder B., Hereil P. and Roncalli T. (2011), Managing Sovereign Credit Risk in Bond Portfolios, Working Paper, www.ssrn.com/abstract=1957050. Campbell J.Y. and Viciera L.M. (2002), Strategic Asset Allocation, Oxford University Press. Choueifaty Y. and Coignard Y. (2008), Toward Maximum Diversification, Journal of Portfolio Management, 35(1), pp. 4051. Choueifaty Y., Froidure T. and Reynier T. (2011), Properties of the Most Diversified Portfolio, Working Paper, www.ssrn.com/abstract=1895459. Clark G.L., CaerlewySmith E. and Marshall J.C. (2006), Pension Fund Trustee Competence: Decision Making in Problems Relevant to Investment Practice, Journal of Pension Economics and Finance, 5(1), pp. 91110. Clarke R., de Silva H. and Thorley S. (2006), Minimumvariance portfolios in the U.S. equity market, Journal of Portfolio Management, 33(1), pp. 1024. Demey P., Maillard S. and Roncalli T. (2010), RiskBased Indexation, Lyxor White Paper Series, 1, www.lyxor.com. DeMiguel V., Garlappi L. and Uppal R. (2009), Optimal Versus Naive Diversification: How Inefficient is the 1/N Portfolio Strategy?, Review of Financial Studies, 22(5), pp. 19151953. Eychenne K., Martinetti S. and Roncalli T. (2011), Strategic Asset Allocation, Lyxor White Paper Series, 6, www.lyxor.com. Eychenne K. and Roncalli T. (2011), Strategic Asset Allocation – An Update following the Sovereign Debt Crisis, Lyxor Short Paper, November, www.lyxor.com. Grinold R.C. and Kahn R.N. (2000), Active Portfolio Management: A Quantitative Approach for Providing Superior Returns and Controlling Risk, second edition, McGrawHill. Hagan P.S., Kumar D., Lesniewski A.S. and Woodward D.E. (2002), Managing Smile Risk, Wilmott Magazine, July, pp. 84108. Hyvärinen A. and Oja E. (2000), Independent Component Analysis: Algorithms and Applications, Neural Networks, 13(45), pp. 411430. Investment Company Institute (2011), Investment Company Fact Book – A Review of Trends and Activity in the Investment Company Industry, 51th edition, www.icifactbook.org. Jagannathan J. and Ma T. (2003), Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps, Journal of Finance, 58(4), pp. 16511683. Laloux L., Cizeau P., Bouchaud JP. and Potters M. (1999), Noise Dressing of Financial Correlation Matrices, Physical Review Letters, 83(7), pp. 14671470. Ledoit, O. and Wolf, M. (2003), Improved Estimation of the Covariance Matrix of Stock Returns With an Application to Portfolio Selection, Journal of Empirical Finance, 10(5), pp. 603621. Ledoit, O. and Wolf, M. (2004), Honey, I Shrunk the Sample Covariance Matrix, Journal of Portfolio Management, 30(4), pp. 110119. Maillard S., Roncalli T. and Teiletche J. (2010), The Properties of Equally Weighted Risk Contributions Portfolios, Journal of Portfolio Management, 36(4), pp. 6070. Martellini L. (2008), Toward the Design of Better Equity Benchmarks, Journal of Portfolio Management, 34(4), pp. 18. Meucci A. (2005), Risk and Asset Allocation, Springer. Michaud R. (1989), The Markowitz Otimization Enigma: Is Optimized Optimal?, Financial Analysts Journal, 45(1), pp. 3142. Qian E. (2006), On the Financial Interpretation of Risk Contributions: Risk Budgets Do Add Up, Journal of Investment Management, Fourth Quarter. Rahl L. (ed.) (2000), Risk Budgeting: A New Approach to Investing, Risk Books. Roncalli T. (2011), Understanding the Impact of Weights Constraints in Portfolio Theory, Working Paper, www.ssrn.com/abstract=1761625. Scherer B. (2007), Portfolio Construction & Risk Budgeting, third edition, Risk Books. Scherer B. (2010), A New Look at Minimum Variance Investing, Working Paper, www.ssrn.com/abstract=1681306. Sharpe W.F. (2002), Budgeting and Monitoring Pension Fund Risk, Financial Analysts Journal, 58(5), pp. 7486. Tütüncü R.H and Koenig M. (2004), Robust Asset Allocation, Annals of Operations Research, 132, pp. 132157 
URI:  https://mpra.ub.unimuenchen.de/id/eprint/37749 
Available Versions of this Item

Managing risk exposures using the risk budgeting approach. (deposited 10. Mar 2012 14:35)
 Managing risk exposures using the risk budgeting approach. (deposited 30. Mar 2012 12:33) [Currently Displayed]