Extending the Risk Parity Approach to Higher Moments: Is There Any Value-Added?

Posted: 1 Nov 2015 Last revised: 1 Feb 2017

Date Written: March 22, 2016

Abstract

The popular risk parity approach is based on volatility as the sole risk measure and therefore lacks the consideration of tail risk. This fact makes risk parity portfolios vulnerable to tail events. In this article the authors address this issue by showing how higher risk moment terms can be consistently incorporated in the risk parity optimization. In addition, they present a novel optimization approach, whereby optimal moment weightings (preferences) in the risk parity optimization are imputed from the data. In a broad-based empirical out-of-sample study and simulation analysis, the authors find superior performance of higher moment risk parity portfolios when the underlying data exhibit significant higher moments and comoments. This fact, according to the authors, renders higher moment risk parity portfolios ideal candidates for worst case regimes.

Keywords: Risk Parity, Higher Moments, Tail Risk, Portfolio Optimization, Certainty Equivalent Return, Quantitative Asset Allocation, Out-of-Sample Study, Normal-inverse Gaussian Distribution

JEL Classification: G10, G11, C61

Suggested Citation

Baitinger, Eduard and Dragosch, André and Topalova, Anastasia, Extending the Risk Parity Approach to Higher Moments: Is There Any Value-Added? (March 22, 2016). The Journal of Portfolio Management, Vol. 43, No. 2 (2017), pp. 24-36.. Available at SSRN: https://ssrn.com/abstract=2682630 or http://dx.doi.org/10.2139/ssrn.2682630

Eduard Baitinger (Contact Author)

FERI Trust GmbH ( email )

Rathausplatz 8-10
Bad Homburg v.d.H, 61348
Germany

André Dragosch

FERI Trust GmbH ( email )

Rathausplatz 8-10
Bad Homburg v.d.H, 61348
Germany

Anastasia Topalova

FERI Trust GmbH ( email )

Rathausplatz 8-10
Bad Homburg v.d.H, 61348
Germany

Register to save articles to
your library

Register

Paper statistics

Abstract Views
1,335
PlumX Metrics