Optimal Risk Budgeting under a Finite Investment Horizon
25 Pages Posted: 7 Dec 2013 Last revised: 5 Jul 2015
Date Written: December 24, 2013
Growth Optimal Portfolio (GOP) theory determines the path of bet sizes that maximize long-term wealth. This multi-horizon goal makes it more appealing among practitioners than myopic approaches, like Markowitz's mean-variance or risk parity. The GOP literature typically considers risk-neutral investors with an infinite investment horizon. In this paper, we compute the optimal bet sizes in the more realistic setting of risk-averse investors with finite investment horizons. We find that, under this more realistic setting, the optimal bet sizes are considerably smaller than previously suggested by the GOP literature. We also develop quantitative methods for determining the risk-adjusted growth allocations (or risk budgeting) for a given finite investment horizon.
Keywords: Growth-optimal portfolio, risk management, Kelly Criterion, finite investment horizon, drawdown
JEL Classification: G10, G60, G70, C62, E60
Suggested Citation: Suggested Citation