Download Risk-Based Approaches to Asset Allocation: Concepts and by Maria Debora Braga PDF

By Maria Debora Braga

This booklet makes a speciality of the innovations and functions of risk-based asset allocation. Markowitz’s conventional method of asset allocation suffers from severe drawbacks whilst applied. those quite often come up from the estimation hazard linked to the required enter the main severe being anticipated returns. With the monetary problem, there was an expanding curiosity in asset allocation techniques that don’t desire anticipated returns as enter, often called risk-based ways. The publication offers an research of the various strategies that healthy this description: the equal-weighting technique, the worldwide minimum-variance procedure, the main varied portfolio procedure and the danger parity technique. as well as a theoretical dialogue of those, it provides sensible functions in numerous funding environments. 3 varied review dimensions are thought of to place those ways to the try: monetary potency, diversification and portfolio stability.

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2 See Fisher and Statman (1997a, b), Benartzi and Thaler (2001), Windcliff and Boyle (2004). 26 After providing these elements, the reason why the equally-weighted approach is included among risk-based strategies, albeit it works without any risk estimate, is because it is an attempt of defence toward risk (alternatively interpreted just as uncertainty or negative event), a sort of (unsophisticated) risk management tool. Certainly, the equally-weighted approach is motivated neither by a focus on a return target nor by the idea of being able to exploit particular performance-generating skills.

Since it is an N-dimensional function, the expansion involves the gradient and the hessian of the function. 4 The Optimal Risk Parity Strategy 31 We observe that, besides the Sequential Quadratic Programming Algorithm, other authors (Chaves et al. 2012) have proposed different approaches to compute the appropriate allocations for an ERC portfolio presenting them as an important simplification for implementing the optimal risk parity strategy. It has to be noted they are based on matrix algebra; neither do they give a specification of an objective function nor do they allow for the insertion of weight constraints.

This normal circumstance motivates the introduction of leverage in the discussion of risk parity strategy. 9 By convention, an investment strategy that exploits financing at the risk free rate is said to be a levered strategy and unlevered otherwise. As noted by Anderson et al. (2012), Levell (2010), Qian (2005, 2011) and Ruban and Meles (2011), the first situation typically occurs in implementing risk parity strategy. There are two major reasons: • traditional portfolios that are rebalanced to become truly risk balanced across asset classes frequently need to have a greater portion in less aggressive asset classes than the actual structure; • empirical evidence has often suggested that some less volatile asset classes exhibit higher risk-adjusted performance (higher Sharpe Ratios) than riskier asset classes but also lower raw returns.

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