Risk Minimization in Multi-Factor Portfolios: What is the Best Strategy?

Posted: 30 Mar 2017 Last revised: 10 Apr 2017

See all articles by Philipp Kremer

Philipp Kremer

EBS Universität für Wirtschaft und Recht; Prime Capital AG

Andreea Talmaciu

JP Morgan

Sandra Paterlini

University of Trento - Department of Economics and Management

Date Written: March 30, 2017

Abstract

Exposures to risk factors, as opposed to individual securities or bonds, can lead to an ex-ante improved risk management and a more transparent and cheaper way of developing active asset allocation strategies. This paper provides an extensive analysis of eight state-of-the-art risk-minimization schemes and compares risk factor performance in a conditional performance analysis, contrasting good and bad states of the economy. The investment universe spans a total of 25 risk factors, including size, momentum, value, high profitability and low investments, from five nonoverlapping regions (i.e., USA, UK, Japan, Developed Europe ex. UK, and Asia ex. Japan). Considering as investment period the interval from May 2004 to June 2015, our results show that each single factor yields positive premia in exchange for risk, which can lead to considerable underperformance and extensive recovery periods during times of crisis. The best factor investments can be found in Asia ex. Japan and the US. However, risk factor based portfolio construction across the various regions enables the investor to exploit low correlation structures, reducing the overall volatility, as well as tail- and extreme risk measures. Finally, the empirical results point towards the long-only global minimum variance portfolio, as the best risk minimization strategy.

Keywords: Risk Factors, Minimum Risk Portfolio, Regularization, Portfolio Optimization, Transaction Cost

Suggested Citation

Kremer, Philipp and Talmaciu, Andreea and Paterlini, Sandra, Risk Minimization in Multi-Factor Portfolios: What is the Best Strategy? (March 30, 2017). Annals of Operations Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2943464 or http://dx.doi.org/10.2139/ssrn.2943464

Philipp Kremer (Contact Author)

EBS Universität für Wirtschaft und Recht ( email )

Gustav-Stresemann-Ring 3
Wiesbaden, Hessen 65195
Germany

Prime Capital AG ( email )

Frankfurt
Germany

Andreea Talmaciu

JP Morgan

London
United Kingdom

Sandra Paterlini

University of Trento - Department of Economics and Management ( email )

Via Inama 5
Trento, I-38100
Italy

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