Minimum Risk vs. Capital and Risk Diversification Strategies for Portfolio Construction
24 Pages Posted: 21 Jan 2015 Last revised: 12 Feb 2015
Date Written: January 20, 2015
In this paper we propose an extensive empirical analysis on three different categories of portfolio selection models, each focused on different objectives: minimization of risk, maximization of capital diversification, and uniform distribution of risk allocation. This latter approach, also called Risk Parity (RP) or Equal Risk Contribution (ERC), is a recent strategy for asset allocation, where the risk measure commonly used to select RP portfolios is volatility. We propose here new developments on the ERC approach based on Conditional Value-at-Risk as risk measure.
We investigate how these classes of portfolio models (Minimum-Risk, Capital and Risk Diversification) work on seven investment universes, each with different sources of risk, which consist of equities, bonds and mixed assets. Then we highlight some strengths and weaknesses of all portfolio strategies in terms of various performance measures.
Keywords: Risk Parity, Diversification, Asset Allocation, Conditional Value-at-Risk, Portfolio Optimization, Smart Beta
JEL Classification: C06, G01
Suggested Citation: Suggested Citation