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Risk parity portfolios with risk factors

Author

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  • T. Roncalli
  • G. Weisang

Abstract

Portfolio construction and risk budgeting are the focus of many studies by academics and practitioners. In particular, diversification has spawned much interest and has been defined very differently. In this paper, we analyse 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 a real example of building a strategic asset allocation based on economic factors for a pension fund facing liability constraints.

Suggested Citation

  • T. Roncalli & G. Weisang, 2016. "Risk parity portfolios with risk factors," Quantitative Finance, Taylor & Francis Journals, vol. 16(3), pages 377-388, March.
    • Handle: RePEc:taf:quantf:v:16:y:2016:i:3:p:377-388
    DOI: 10.1080/14697688.2015.1046907
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    References listed on IDEAS

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    1. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    2. Bruder, Benjamin & Roncalli, Thierry, 2012. "Managing risk exposures using the risk budgeting approach," MPRA Paper 37246, University Library of Munich, Germany.
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General

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