Extending the Risk Parity Approach to Higher Moments: Is There Any Value-Added?

Baitinger, Eduard; Dragosch, André; Topalova, Anastasia

doi:10.2139/ssrn.2682630

Cited by 2 publications

(2 citation statements)

References 14 publications

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“…For example, non-quadratic measures of risk, such as skewness or kurtosis, would break rotational symmetry and possibly lead to meaningful fundamental risk factors that should be maximally diversified (see e.g. [19]). We leave this for future work.…”

Section: Perspectivesmentioning

confidence: 99%

Agnostic Risk Parity: Taming Known and Unknown-Unknowns

et al. 2016

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Markowitz' celebrated optimal portfolio theory generally fails to deliver out-of-sample diversification. In this note, we propose a new portfolio construction strategy based on symmetry arguments only, leading to "Eigenrisk Parity" portfolios that achieve equal realized risk on all the principal components of the covariance matrix. This holds true for any other definition of uncorrelated factors. We then specialize our general formula to the most agnostic case where the indicators of future returns are assumed to be uncorrelated and of equal variance. This "Agnostic Risk Parity" (AGP) portfolio minimizes unknown-unknown risks generated by over-optimistic hedging of the different bets. AGP is shown to fare quite well when applied to standard technical strategies such as trend following.

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Section: Perspectivesmentioning

confidence: 99%

Agnostic Risk Parity: Taming Known and Unknown-Unknowns

et al. 2016

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“…Bai et al (2016) show that Electronic copy available at: https://ssrn.com/abstract=3285156 long-short asset-variance-parity portfolios are no longer unique. Boudt et al (2013) and Baitinger et al (2017) consider higher moments in asset-risk parity. Two recent remarkable contributions are those in Haugh et al (2017) and Ji and Lejeune (2015).…”

Section: Introductionmentioning

confidence: 99%

Optimal Portfolio Diversification via Independent Component Analysis

Lassance

DeMiguel

Vrins

2022

Operations Research

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A natural approach to enhance portfolio diversification is to rely on factor-risk parity, which yields the portfolio whose risk is equally spread among a set of uncorrelated factors. The standard choice is to take the variance as risk measure, and the principal components (PCs) of asset returns as factors. Although PCs are unique and useful for dimension reduction, they are an arbitrary choice: any rotation of the PCs results in uncorrelated factors. This is problematic because we demonstrate that any portfolio is a factor-variance-parity portfolio for some rotation of the PCs. More importantly, choosing the PCs does not account for the higher moments of asset returns. To overcome these issues, we propose using the independent components (ICs) as factors, which are the rotation of the PCs that are maximally independent, and care about higher moments of asset returns. We demonstrate that using the IC-variance-parity portfolio helps to reduce the return kurtosis. We also show how to exploit the near independence of the ICs to parsimoniously estimate the factor-risk-parity portfolio based on value at risk. Finally, we empirically demonstrate that portfolios based on ICs outperform those based on PCs, and several state-of-the-art benchmarks.

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Extending the Risk Parity Approach to Higher Moments: Is There Any Value-Added?

Cited by 2 publications

References 14 publications

Agnostic Risk Parity: Taming Known and Unknown-Unknowns

Agnostic Risk Parity: Taming Known and Unknown-Unknowns

Optimal Portfolio Diversification via Independent Component Analysis

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