Agnostic Risk Parity: Taming Known and Unknown-Unknowns

12 Pages Posted: 29 Oct 2016

See all articles by Raphael Benichou

Raphael Benichou

Capital Fund Management

Yves Lemperiere

Capital Fund Management

Emmanuel Sérié

Capital Fund Management

Julien Kockelkoren

Capital Fund Management

Philip Seager

Capital Fund Management

Jean-Philippe Bouchaud

Capital Fund Management

Marc Potters

Capital Fund Management

Date Written: October 27, 2016

Abstract

Markowitz' celebrated optimal portfolio theory generally fails to deliver out-of-sample diversification. In this note, we propose a new portfolio construction strategy based on symmetry arguments only, leading "Eigenrisk Parity" portfolios that achieve equal realized risk on all the principal components of the covariance matrix. This holds true for any other definition of uncorrelated factors. We then specialize our general formula to the most agnostic case where the indicators of future returns are assumed to be uncorrelated and of equal variance. This "Agnostic Risk Parity" (AGP) portfolio minimizes unknown-unknown risks generated by over-optimistic hedging of the different bets. AGP is shown to fare quite well when applied to standard technical strategies such as trend following.

Keywords: Quantitative Portfolio Management, Portfolio Construction, Asset Allocation, Risk Parity, Risk Budgeting, Diversification, Markowitz, Alternative Beta

JEL Classification: G11, D81, C1

Suggested Citation

Benichou, Raphael and Lemperiere, Yves and Sérié, Emmanuel and Kockelkoren, Julien and Seager, Philip and Bouchaud, Jean-Philippe and Potters, Marc, Agnostic Risk Parity: Taming Known and Unknown-Unknowns (October 27, 2016). Available at SSRN: https://ssrn.com/abstract=2860037 or http://dx.doi.org/10.2139/ssrn.2860037

Raphael Benichou (Contact Author)

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

Yves Lemperiere

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

Emmanuel Sérié

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

Julien Kockelkoren

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

Philip Seager

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

Jean-Philippe Bouchaud

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France
+33 1 49 49 59 20 (Phone)

Marc Potters

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France
+33 1 49 49 59 10 (Phone)
+33 1 47 70 17 40 (Fax)

HOME PAGE: http://www.cfm.fr

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