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

By Maria Debora Braga

This e-book makes a speciality of the recommendations and purposes of risk-based asset allocation. Markowitz’s conventional method of asset allocation suffers from critical drawbacks while carried out. those in general come up from the estimation possibility linked to the required enter the main serious being anticipated returns. With the monetary main issue, there was an expanding curiosity in asset allocation techniques that don’t desire anticipated returns as enter, referred to as risk-based techniques. The booklet offers an research of different recommendations that healthy this description: the equal-weighting process, the worldwide minimum-variance procedure, the main various portfolio strategy and the chance parity technique. as well as a theoretical dialogue of those, it provides useful purposes in several funding environments. 3 various review dimensions are thought of to place those techniques to the try out: monetary potency, diversification and portfolio stability.

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Given that leverage means to be financed, we have to acknowledge that, in extreme market conditions, the roll-over of loans is subject to uncertainty and/or the possibility to be forced to execute distressed sales because of significant changes of the borrowing rates and of the assets value. Furthermore, it can be taken for granted that leverage not only amplifies returns, it also exacerbates losses and the impact of tail events. To conclude, it is important to emphasize that we share the idea of levered risk parity portfolio adopted by Qian (2011), that is leverage applied to the entire “source” portfolio.

It is the most straightforward risk-based strategy because there are no parameter estimates involved considering that its implementation does not entail an optimization problem to be solved. The reason for this is very simple: all asset classes are given the same weight. Then, we explore the global minimum-variance approach which is the only risk-based strategy that, with absolute certainty, recommends a portfolio located on the Efficient Frontier: the portfolio at the most left end. Finally, we take into consideration the most diversified portfolio approach.

Its mean return is higher than that of the traditional portfolio considering approximately the leverage cost (7:04 % ¼ 4:95 % Á 98:79 % þ 8:37 % Á 31:88 % À 30:67 % Á 1:68 %) and preserves the risk parity risk-adjusted performance. 4 % risk parity portfolio up along the line which in a risk— return space passes both through the cash (risk-free rate) position and the risk parity portfolio. 1 shows this movement. We can safely say that every combination of the cash position and the risk parity portfolio will stay on this line.

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