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Minimum risk versus capital and risk diversification strategies for portfolio construction

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  • Francesco Cesarone
  • Stefano Colucci

Abstract

In this paper, we propose an extensive empirical analysis on three categories of portfolio selection models with very different objectives: minimization of risk, maximization of capital diversification, and uniform distribution of risk allocation. The latter approach, also called Risk Parity or Equal Risk Contribution (ERC), is a recent strategy for asset allocation that aims at equally sharing the risk among all the assets of the selected portfolio. The risk measure commonly used to select ERC portfolios is volatility. We propose here new developments of the ERC approach using Conditional Value-at-Risk (CVaR) as a risk measure. Furthermore, under appropriate conditions, we also provide an approach to find a CVaR ERC portfolio as a solution of a convex optimization problem. We investigate how these classes of portfolio models (Minimum-Risk, Capital-Diversification, and Risk-Diversification) work on seven investment universes, each with different sources of risk, including equities, bonds, and mixed assets. Then, we highlight some strengths and weaknesses of all portfolio strategies in terms of various performance measures.

Suggested Citation

  • Francesco Cesarone & Stefano Colucci, 2018. "Minimum risk versus capital and risk diversification strategies for portfolio construction," Journal of the Operational Research Society, Taylor & Francis Journals, vol. 69(2), pages 183-200, February.
    • Handle: RePEc:taf:tjorxx:v:69:y:2018:i:2:p:183-200
    DOI: 10.1057/s41274-017-0216-5
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    Citations

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    Cited by:

    1. Francesco Cesarone & Raffaello Cesetti & Giuseppe Orlando & Manuel Luis Martino & Jacopo Maria Ricci, 2022. "Comparing SSD-Efficient Portfolios with a Skewed Reference Distribution," Mathematics, MDPI, vol. 11(1), pages 1-20, December.
    2. Prayut Jain & Shashi Jain, 2019. "Can Machine Learning-Based Portfolios Outperform Traditional Risk-Based Portfolios? The Need to Account for Covariance Misspecification," Risks, MDPI, vol. 7(3), pages 1-27, July.
    3. Francesco Cesarone & Andrea Scozzari & Fabio Tardella, 2020. "An optimization–diversification approach to portfolio selection," Journal of Global Optimization, Springer, vol. 76(2), pages 245-265, February.
    4. Cesarone, Francesco & Mango, Fabiomassimo & Mottura, Carlo Domenico & Ricci, Jacopo Maria & Tardella, Fabio, 2020. "On the stability of portfolio selection models," Journal of Empirical Finance, Elsevier, vol. 59(C), pages 210-234.
    5. Gilles Boevi Koumou, 2020. "Diversification and portfolio theory: a review," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 34(3), pages 267-312, September.
    6. Timo Dimitriadis & Yannick Hoga, 2023. "Regressions under Adverse Conditions," Papers 2311.13327, arXiv.org, revised Jul 2024.
    7. Tuncer Yılmaz & Bülent Yıldız, 2022. "Yatırımcıların Risk İştahı Endeksi İle Korku Endeksleri Arasındaki İlişki: Türkiye’de ARDL İle Ampirik Bir Uygulama," Journal of Research in Economics, Politics & Finance, Ersan ERSOY, vol. 7(3), pages 646-676.
    8. Francesco Cesarone & Manuel L. Martino & Fabio Tardella, 2023. "Mean-Variance-VaR portfolios: MIQP formulation and performance analysis," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 45(3), pages 1043-1069, September.
    9. Francesco Cesarone & Manuel Luis Martino & Alessandra Carleo, 2022. "Does ESG Impact Really Enhance Portfolio Profitability?," Sustainability, MDPI, vol. 14(4), pages 1-28, February.

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