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Optimal Risk Budgeting under a Finite Investment Horizon

Author

Listed:
  • Marcos López de Prado

    (Lawrence Berkeley National Laboratory, Berkeley, CA 94720, USA)

  • Ralph Vince

    (Vince Strategies, LLC, The Chrysler Building, 405 Lexington Ave 26th fl., New York, NY 10174, USA)

  • Qiji Jim Zhu

    (Department of Mathematics, Western Michigan University, 1903 West Michigan Avenue, Kalamazoo, MI 49008, USA)

Abstract

The Growth-Optimal Portfolio (GOP) theory determines the path of bet sizes that maximize long-term wealth. This multi-horizon goal makes it more appealing among practitioners than myopic approaches, like Markowitz’s mean-variance or risk parity. The GOP literature typically considers risk-neutral investors with an infinite investment horizon. In this paper, we compute the optimal bet sizes in the more realistic setting of risk-averse investors with finite investment horizons. We find that, under this more realistic setting, the optimal bet sizes are considerably smaller than previously suggested by the GOP literature. We also develop quantitative methods for determining the risk-adjusted growth allocations (or risk budgeting) for a given finite investment horizon.

Suggested Citation

  • Marcos López de Prado & Ralph Vince & Qiji Jim Zhu, 2019. "Optimal Risk Budgeting under a Finite Investment Horizon," Risks, MDPI, vol. 7(3), pages 1-15, August.
    • Handle: RePEc:gam:jrisks:v:7:y:2019:i:3:p:86-:d:254877
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    References listed on IDEAS

    as
    1. Henry Allen Latane, 1959. "Criteria for Choice Among Risky Ventures," Journal of Political Economy, University of Chicago Press, vol. 67(2), pages 144-144.
    2. Stanislaus Maier-Paape & Qiji Jim Zhu, 2018. "A General Framework for Portfolio Theory. Part II: Drawdown Risk Measures," Risks, MDPI, vol. 6(3), pages 1-31, August.
    3. Philippe Artzner & Freddy Delbaen & Jean‐Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228, July.
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