Active Risk Budgeting is better than the Tangency Portfolio

15 Pages Posted: 2 May 2019 Last revised: 15 May 2019

Date Written: January 1, 2019

Abstract

In this paper, we show empirically that Active Risk Budgeting is a superior portfolio construction methodology to the tangency portfolio method postulated by Mean Variance Optimization. We compare the performance of Active Risk Budgeting and Tangency Portfolio in a series of systematic experiments as we gradually increase the predictive accuracy of the input signal. We find that almost always Active Risk Budgeting has better returns. Only when the signal used for portfolio construction perfectly knows the Sharpe Ratio of the securities in the next five days does the performance of the tangency portfolio catch up to Active Risk Budgeting. Given the results, we would recommend the use of Active Risk Budgeting in portfolio construction for active investment strategies on derivatives.

Keywords: Portfolio Construction, Position Sizing, Managed Futures, Portfolio Optimization, Risk Budgeting, Risk Parity

JEL Classification: C00, C10, C45, C50, G00, G11

Suggested Citation

Chakravorty, Gaurav and Awasthi, Ankit and Singhal, Mansi and gupta, sanchit and Srivastava, Sonam, Active Risk Budgeting is better than the Tangency Portfolio (January 1, 2019). Available at SSRN: https://ssrn.com/abstract=3376067 or http://dx.doi.org/10.2139/ssrn.3376067

Gaurav Chakravorty (Contact Author)

Qplum ( email )

Harborside 5, 185 Hudson St, Suite 1620
Jersey City, NJ 07311
United States
2013772302 (Phone)

HOME PAGE: http://https://www.qplum.co

Ankit Awasthi

affiliation not provided to SSRN

Mansi Singhal

Qplum ( email )

Harborside 5, 185 Hudson St, Suite 1620
Jersey City, NJ 07311
United States
2013772302 (Phone)

HOME PAGE: http://www.qplum.co

Sanchit Gupta

Qplum ( email )

Harborside 5, 185 Hudson St, Suite 1620
Jersey City, NJ 07311
United States
2013772302 (Phone)

HOME PAGE: http://www.qplum.co

Sonam Srivastava

Wright Research ( email )

Mumbai, 400098
India

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