Risk Budgeting Allocation for Dynamic Risk Measures

Abstract

We define and develop an approach for risk budgeting allocation-a risk diversification portfolio strategy-where risk is measured using a dynamic time-consistent risk measure. For this, we introduce a notion of dynamic risk contributions that generalise the classical Euler contributions and which allow us to obtain dynamic risk contributions in a recursive manner. We prove that, for the class of coherent dynamic distortion risk measures, the risk allocation problem may be recast as a sequence of strictly convex optimisation problems. Moreover, we show that self-financing dynamic risk budgeting strategies with initial wealth of 1 are scaled versions of the solution of the sequence of convex optimisation problems. Furthermore, we develop an actor-critic approach, leveraging the elicitability of dynamic risk measures, to solve for risk budgeting strategies using deep learning.

Keywords: Dynamic Risk Measures, Portfolio Allocation, Risk Parity, Elicitability, Deep Learning

JEL Classification: G11, C61, C45