Beyond Risk-Based Portfolios: Balancing Performance and Risk Contributions in Asset Allocation

Quantitative Finance, Forthcoming

42 Pages Posted: 11 Aug 2016 Last revised: 6 Jan 2018

David Ardia

University of Neuchatel - Institute of Financial Analysis; Laval University - Département de Finance et Assurance

Kris Boudt

Vrije Universiteit Brussel (VUB); VU University Amsterdam

Giang Nguyen

Vrije Universiteit Brussel (VUB)

Date Written: November 11, 2016

Abstract

In a risk-based portfolio, there is no explicit control for the performance per unit of risk taken. We propose a framework to evaluate the balance between risk and performance at both the portfolio and component level, and to tilt the risk-based portfolio weights towards a state in which the performance and risk contributions are aligned. The key innovation is the Performance/Risk Contribution Concentration (PRCC) measure, which is designed to be minimal when, for all portfolio components, the performance and risk contributions are perfectly aligned. We investigate the theoretical properties of this measure and show its usefulness to obtain the PRCC modified risk-based portfolio weights, that avoid excesses in terms of deviations between the performance and risk contributions of the portfolio components, while still being close to the benchmark risk-based portfolio in terms of weights and relative performance.

Keywords: Asset Allocation, Performance/Risk Contribution, Target Relative Performance Portfolio

JEL Classification: C12, C21, C22

Suggested Citation

Ardia, David and Boudt, Kris and Nguyen, Giang, Beyond Risk-Based Portfolios: Balancing Performance and Risk Contributions in Asset Allocation (November 11, 2016). Quantitative Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2819789 or http://dx.doi.org/10.2139/ssrn.2819789

David Ardia

University of Neuchatel - Institute of Financial Analysis ( email )

Rue A.-L. Breguet 2
Neuchatel, CH-2000
Switzerland

Laval University - Département de Finance et Assurance ( email )

Pavillon Palasis-Prince
Quebec G1K 7P4
Canada

Kris Boudt (Contact Author)

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Giang Nguyen

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

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