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The Risk Parity Principle applied on a Corporate Bond Index using Duration Times Spread

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  • Lauren Stagnol

Abstract

In this paper, we apply the principle of Equal Risk Contribution (ERC) to a corporate bond index, an asset class so far left behind in this literature. Specifically, we rely on the Duration Time Spread (DTS) and demonstrate that it is an coherent metric for bond risk. We construct indexes based on sector - issuer - and bond level using structured block correlation matrices, weights being inversely proportional to DTS. Our results provide evidence that applying ERC using DTS in the index design significantly improves corporate bond index risk-adjusted returns. It appears that the higher the granularity is, the higher will be the risk adjusted performance enhancements. More generally, the ERC application we present appears to be a valuable trade-off between heuristic and more complex risk-modeling based weighting schemes.

Suggested Citation

  • Lauren Stagnol, 2016. "The Risk Parity Principle applied on a Corporate Bond Index using Duration Times Spread," EconomiX Working Papers 2016-27, University of Paris Nanterre, EconomiX.
    • Handle: RePEc:drm:wpaper:2016-27
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    References listed on IDEAS

    as
    1. Marielle de Jong & Hongwen Wu, 2014. "Fundamental indexation for bond markets," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 15(3), pages 264-274, May.
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    More about this item

    Keywords

    Equal Risk Contribution; Risk Parity; Smart Beta; Risk Measure; Risk-Based Indexing; Alternative Corporate Bond Index.;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General

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