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A Volatility Driven Asset Allocation

19 Pages Posted: 13 Nov 2010  

Laurent Michel

Lombard Odier & Cie

Thierry Michel

Lombard Odier & Cie

Christophe Morel

Université Paris Dauphine - DRM-CEREG

Date Written: November 9, 2010

Abstract

This article advocates a systematic rebalancing process - Volatility-Driven Asset Allocation or VDAA - for dynamically managing the strategic asset allocation. The goal of the suggested algorithm is to adjust the asset exposures so as to reflect the assumptions investors used when determining their strategic allocation, in terms of balance between risk contributions and expected returns. Such an idea makes sense from the economic point of view of a risk-adverse investor who wishes to achieve a smooth long-run performance. The stable risk contribution is determined by a long-run target, with short-term deviations from this target driving the rebalancing of the portfolio exposure. Rebalancing between asset classes allows smoothing the global volatility of the portfolio by decreasing exposure in asset classes yielding temporarily higher risk contributions and by increasing weight in asset classes with temporarily lower risk contributions. Both our backtests and robustness study demonstrate that this risk rebalancing strategy is superior in terms of information ratio to traditional rebalancing rules.

Keywords: asset allocation, rebalancing strategy, volatility

JEL Classification: G11, G15

Suggested Citation

Michel, Laurent and Michel, Thierry and Morel, Christophe, A Volatility Driven Asset Allocation (November 9, 2010). Available at SSRN: https://ssrn.com/abstract=1706221 or http://dx.doi.org/10.2139/ssrn.1706221

Laurent Michel

Lombard Odier & Cie ( email )

11 rue de la Corraterie
1211 Geneva 11
Switzerland

Thierry Michel (Contact Author)

Lombard Odier & Cie ( email )

11 rue de la Corraterie
Geneva, 1211
Switzerland

Christophe Morel

Université Paris Dauphine - DRM-CEREG ( email )

place du Maréchal de Lattre de Tassigny
cedex 16
Paris, 75775
France

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