The risk parity approach to asset allocation

Galane, Lesiba Charles (2014-12)

Thesis (MSc)--Stellenbosch University, 2014.

Thesis

ENGLISH ABSTRACT: We consider the problem of portfolio's asset allocation characterised by risk and return. Prior to the 2007-2008 financial crisis, this important problem was tackled using mainly the Markowitz mean-variance framework. However, throughout the past decade of challenging markets, particularly for equities, this framework has exhibited multiple drawbacks. Today many investors approach this problem with a 'safety first' rule that puts risk management at the heart of decision-making. Risk-based strategies have gained a lot of popularity since the recent financial crisis. One of the 'trendiest' of the modern risk-based strategies is the Risk Parity model, which puts diversification in terms of risk, but not in terms of dollar values, at the core of portfolio risk management. Inspired by the works of Maillard et al. (2010), Bruder and Roncalli (2012), and Roncalli and Weisang (2012), we examine the reliability and relationship between the traditional mean-variance framework and risk parity. We emphasise, through multiple examples, the non-diversification of the traditional mean-variance framework. The central focus of this thesis is on examining the main Risk-Parity strategies, i.e. the Inverse Volatility, Equal Risk Contribution and the Risk Budgeting strategies. Lastly, we turn our attention to the problem of maximizing the absolute expected value of the logarithmic portfolio wealth (sometimes called the drift term) introduced by Oderda (2013). The drift term of the portfolio is given by the sum of the expected price logarithmic growth rate, the expected cash flow, and half of its variance. The solution to this problem is a linear combination of three famous risk-based strategies and the high cash flow return portfolio.

AFRIKAANSE OPSOMMING: Ons kyk na die probleem van batetoewysing in portefeuljes wat gekenmerk word deur risiko en wins. Voor die 2007-2008 finansiele krisis, was hierdie belangrike probleem deur die Markowitz gemiddelde-variansie raamwerk aangepak. Gedurende die afgelope dekade van uitdagende markte, veral vir aandele, het hierdie raamwerk verskeie nadele getoon. Vandag, benader baie beleggers hierdie probleem met 'n 'veiligheid eerste' reël wat risikobestuur in die hart van besluitneming plaas. Risiko-gebaseerde strategieë het baie gewild geword sedert die onlangse finansiële krisis. Een van die gewildste van die moderne risiko-gebaseerde strategieë is die Risiko- Gelykheid model wat diversifikasie in die hart van portefeulje risiko bestuur plaas. Geïnspireer deur die werke van Maillard et al. (2010), Bruder and Roncalli (2012), en Roncalli and Weisang (2012), ondersoek ons die betroubaarheid en verhouding tussen die tradisionele gemiddelde-variansie raamwerk en Risiko- Gelykheid. Ons beklemtoon, deur middel van verskeie voorbeelde, die niediversifikasie van die tradisionele gemiddelde-variansie raamwerk. Die sentrale fokus van hierdie tesis is op die behandeling van Risiko-Gelykheid strategieë, naamlik, die Omgekeerde Volatiliteit, Gelyke Risiko-Bydrae en Risiko Begroting strategieë. Ten slotte, fokus ons aandag op die probleem van maksimering van absolute verwagte waarde van die logaritmiese portefeulje welvaart (soms genoem die drif term) bekendgestel deur Oderda (2013). Die drif term van die portefeulje word gegee deur die som van die verwagte prys logaritmiese groeikoers, die verwagte kontantvloei, en die helfte van die variansie. Die oplossing vir hierdie probleem is 'n lineêre kombinasie van drie bekende risiko-gebaseerde strategieë en die hoë kontantvloei wins portefeulje.

Please refer to this item in SUNScholar by using the following persistent URL: http://hdl.handle.net/10019.1/95974
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