A Risk Weighted Approach Designed to Manage Bond Exposures in a Low Interest Rate Environment

28 Pages Posted: 5 Aug 2013

See all articles by Patrick Beaudan

Patrick Beaudan

Northern Trust Corporation; Emotomy

Date Written: August 5, 2013

Abstract

Risk-based investing techniques such as risk parity are encountering market conditions no longer as favorable as in the past. Their principal weakness is the implicit assumption that the volatility of an asset is a fair quantification of investment risk. As a result, low volatility assets are assigned higher portfolio weights. In the case of bonds however, realized volatility is not a good indicator of risk in a low or rising interest rate environment. An approach that treats bonds on the basis of low historical volatility is therefore possibly building significant tail risk in its portfolios. In this paper, we propose an alternative risk-weighted approach to portfolio construction that enables investors to account for hidden risks in low volatility securities.

Keywords: Risk parity, volatility weighted portfolio allocation, bond risk, permanent portfolio, all weather portfolio

JEL Classification: C22, J11

Suggested Citation

Beaudan, Patrick, A Risk Weighted Approach Designed to Manage Bond Exposures in a Low Interest Rate Environment (August 5, 2013). Available at SSRN: https://ssrn.com/abstract=2305895 or http://dx.doi.org/10.2139/ssrn.2305895

Patrick Beaudan (Contact Author)

Northern Trust Corporation ( email )

50 South LaSalle Street
Chicago, IL 60603
United States
415 839 5239 (Phone)

Emotomy ( email )

2 Embarcadero Center
San Francisco, CA 94111
United States

HOME PAGE: http://www.emotomy.com

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