Risk Parity Portfolios with Skewness Risk: An Application to Factor Investing and Alternative Risk Premia

48 Pages Posted: 23 Sep 2016  

Benjamin Bruder

Lyxor Asset Management

Nazar Kostyuchyk

Lyxor Asset Management

Thierry Roncalli

Amundi Asset Management; University of Evry

Date Written: September 22, 2016

Abstract

This article develops a model that takes into account skewness risk in risk parity portfolios. In this framework, asset returns are viewed as stochastic processes with jumps or random variables generated by a Gaussian mixture distribution. This dual representation allows us to show that skewness and jump risks are equivalent. As the mixture representation is simple, we obtain analytical formulas for computing asset risk contributions of a given portfolio. Therefore, we define risk budgeting portfolios and derive existence and uniqueness conditions. We then apply our model to the equity/bond/volatility asset mix policy. When assets exhibit jump risks like the short volatility strategy, we show that skewness-based risk parity portfolios produce better allocation than volatility-based risk parity portfolios. Finally, we illustrate how this model is suitable to manage the skewness risk of long-only equity factor portfolios and to allocate between alternative risk premia.

Keywords: Risk Parity, Equal Risk Contribution, Expected Shortfall, Skewness, Jump Diffusion, Gaussian Mixture Model, EM Algorithm, Filtering Theory, Factor Investing, Alternative Risk Premia, Short Volatility Strategy, Diversification, Skewness Hedging, CTA Strategy

JEL Classification: C50, C60, G11

Suggested Citation

Bruder, Benjamin and Kostyuchyk, Nazar and Roncalli, Thierry, Risk Parity Portfolios with Skewness Risk: An Application to Factor Investing and Alternative Risk Premia (September 22, 2016). Available at SSRN: https://ssrn.com/abstract=2813384 or http://dx.doi.org/10.2139/ssrn.2813384

Benjamin Bruder

Lyxor Asset Management ( email )

Paris
France

Nazar Kostyuchyk

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

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