Risk Parity Portfolios with Risk Factors

32 Pages Posted: 3 Oct 2012 Last revised: 6 Oct 2012

Thierry Roncalli

Amundi Asset Management; University of Evry

Guillaume Weisang

Clark University - Graduate School of Management

Date Written: September 21, 2012

Abstract

Portfolio construction and risk budgeting are the focus of many studies by academics and practitioners. In particular, diversification has spawn much interest and has been defined very differently. In this paper, we analyze a method to achieve portfolio diversification based on the decomposition of the portfolio's risk into risk factor contributions. First, we expose the relationship between risk factor and asset contributions. Secondly, we formulate the diversification problem in terms of risk factors as an optimization program. Finally, we illustrate our methodology with some real life examples and backtests, which are: budgeting the risk of Fama-French equity factors, maximizing the diversification of an hedge fund portfolio and building a strategic asset allocation based on economic factors.

Keywords: risk parity, risk budgeting, factor model, ERC portfolio, diversification, concentration, Fama-French model, hedge fund allocation, strategic asset allocation

JEL Classification: G11, C58, C60.

Suggested Citation

Roncalli, Thierry and Weisang, Guillaume, Risk Parity Portfolios with Risk Factors (September 21, 2012). Available at SSRN: https://ssrn.com/abstract=2155159 or http://dx.doi.org/10.2139/ssrn.2155159

Thierry Roncalli (Contact Author)

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

University of Evry ( email )

Boulevard Francois Mitterrand
F-91025 Evry Cedex
France

Guillaume Weisang

Clark University - Graduate School of Management ( email )

950 Main Street
Worcester, MA 01610
United States

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