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Parametric Risk Parity

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  • Lorenzo Mercuri
  • Edit Rroji

Abstract

Any optimization algorithm based on the risk parity approach requires the formulation of portfolio total risk in terms of marginal contributions. In this paper we use the independence of the underlying factors in the market to derive the centered moments required in the risk decomposition process when the modified versions of Value at Risk and Expected Shortfall are considered. The choice of the Mixed Tempered Stable distribution seems adequate for fitting skewed and heavy tailed distributions. The ensuing detailed description of the optimization procedure is due to the existence of analytical higher order moments. Better results are achieved in terms of out of sample performance and greater diversification.

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  • Lorenzo Mercuri & Edit Rroji, 2014. "Parametric Risk Parity," Papers 1409.7933, arXiv.org.
    • Handle: RePEc:arx:papers:1409.7933
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    References listed on IDEAS

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    1. Gourieroux, C. & Laurent, J. P. & Scaillet, O., 2000. "Sensitivity analysis of Values at Risk," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 225-245, November.
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    11. Dirk Tasche, 2002. "Expected Shortfall and Beyond," Papers cond-mat/0203558, arXiv.org, revised Oct 2002.
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