A Primer on Alternative Risk Premia

123 Pages Posted: 4 May 2016 Last revised: 26 Jun 2016

Rayann Hamdan

Lyxor Asset Management

Fabien Pavlowsky

Lyxor Asset Management

Thierry Roncalli

Amundi Asset Management; University of Evry

Ban Zheng

Lyxor Asset Management; Télécom ParisTech; Ecole Centrale Paris

Date Written: April 1, 2016

Abstract

The concept of alternative risk premia can be viewed as an extension of the factor investing approach. Factor investing is a term that is generally dedicated to long-only equity risk factors. A typical example is the value equity strategy. Alternative risk premia designate non-traditional risk premia other than long exposure to equities and bonds. They may concern equities, rates, credit, currencies or commodities and correspond to long/short portfolios. For instance, the value strategy can be extended to credit, currencies and commodities. This paper provides an overview of the different alternative risk premia to be found in the academic and professional spheres. Using a database of commercial indices, we estimate the generic cumulative returns of 59 alternative risk premia in order to analyze their risk, diversification power and payoff function. From this, it is clear that the term "alternative risk premia" encompasses two different types of risk factor: skewness risk premia and market anomalies. We then reconsider portfolio allocation in light of this framework. Indeed, we show that skewness aggregation is considerably more complex than volatility aggregation, and we illustrate that the volatility risk measure is less appropriate and pertinent when managing a portfolio with these risk premia. The development of alternative risk premia shall also affect the risk/return analysis of non-linear strategies, e.g. hedge fund strategies. In particular, using alternative risk factors instead of traditional risk factors leads to an extension of the alternative beta framework. Therefore, we apply the previously estimated risk premia to a universe of hedge fund indices. To that end, we develop a model selection based on the lasso regression to identify the most pertinent risk premia for each hedge fund strategy. It appears that many traditional risk factors, with the exception of long equity and credit exposure on developed markets, vanish when we include alternative risk premia.

Keywords: Alternative Risk Premium, Factor Investing, Skewness Risk Premium, Market Anomaly, Risk Factor, Carry, Event, Growth, Liquidity, Low Beta, Low Volatility, Momentum, Quality, Reversal, Value, Short Volatility, Size, Skewness, Drawdown, Option Profile, Alternative Beta, Hedge Funds

JEL Classification: C50, C60, G11

Suggested Citation

Hamdan, Rayann and Pavlowsky, Fabien and Roncalli, Thierry and Zheng, Ban, A Primer on Alternative Risk Premia (April 1, 2016). Available at SSRN: https://ssrn.com/abstract=2766850

Rayann Hamdan

Lyxor Asset Management ( email )

Paris
France

Fabien Pavlowsky

Lyxor Asset Management ( email )

Paris
France

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

Ban Zheng

Lyxor Asset Management ( email )

17 Cours Valmy
Paris La Défense, 92987
France

Télécom ParisTech ( email )

46 rue Barrault
F-75634 Paris, Cedex 13
France

Ecole Centrale Paris ( email )

Grande Voie des Vignes
Chātenay-Malabry, 92295
France

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