Extending Risk Budgeting for Market Regimes and Quantile Factor Models

22 Pages Posted: 20 Mar 2018

See all articles by Emlyn James Flint

Emlyn James Flint

Legae Peresec; Department of Actuarial Science, University of Cape Town

Simon du Plooy

North West University; Corion Capital

Date Written: March 15, 2018


We combine several disparate avenues in the literature to create a novel, unified risk-based optimisation framework. Specifically, we extend the existing risk budgeting approach of Richard and Roncalli (2015) to allow for changing market regimes, factor dependence and nonlinear and asymmetric market structure. We show that the existing framework can be readily extended to include a factor-dependent return process using standard models available in the literature. Structural changes in market conditions are then incorporated into the framework through the use of a regime-switching turbulence index and the nonlinear and asymmetric market dependence structure is accounted for by using quantile factor models. Most importantly, this extended framework is only comprised of a series of linear models, and is thus simple to understand and implement. We consider two applications of the extended framework, namely scenario analysis and parameter uncertainty analysis, through means of a simple empirical case study. Finally, we introduce the concept of Risk Maps, which provide managers with a graphical approach for estimating and evaluating risk optimality in a multi-objective and multi-scenario setting.

Keywords: risk budgeting, risk-based optimisation, market regimes, quantile factor models, multi-objective optimisation

JEL Classification: C02, C31, C32, C53, C61, G11

Suggested Citation

Flint, Emlyn James and du Plooy, Simon Johannes, Extending Risk Budgeting for Market Regimes and Quantile Factor Models (March 15, 2018). Available at SSRN: https://ssrn.com/abstract=3141739 or http://dx.doi.org/10.2139/ssrn.3141739

Emlyn James Flint (Contact Author)

Legae Peresec ( email )

15 Cavendish Street
Cape Town, Western Cape 7700
South Africa
27117227556 (Phone)

HOME PAGE: http://www.legaeperesec.co.za

Department of Actuarial Science, University of Cape Town ( email )

Actuarial Science Section, University of Cape Town
Private Bag X3, Rondebosch
Cape Town, Western Cape 7701
South Africa
+27 21 650 2475 (Phone)

Simon Johannes Du Plooy

North West University ( email )

Hoffman Street
Potchefstroom, 2520
South Africa

HOME PAGE: http://natural-sciences.nwu.ac.za/bmi

Corion Capital ( email )

41 Sir Lowry Road
Cape Town, Western Cape 7925
South Africa

HOME PAGE: http://www.corion.co.za

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