7/24/2023 0 Comments Drawdown fund rebalance strategy![]() Let's compare long-only portfolios consist of five stocks, SPY, EFA, TIP, GSG, and VNQ, to represent US, international, treasury, commodity, real estates, respectively, between 2011-2019. The essence is equal/parity risk contribution (ERC) defined as ![]() It focuses on budgeting and allocation of risks rather than capitals. ![]() Risk parity was coined by Edward Qian () and popularized by Bridgewater all weather fund. If we have no knowledge at all about the market, a naive equal-weighting portfolio will be a default option, which is also served as benchmark in our backtest. If expected return is hard to measure, covariance knowledge can be leveraged to construct minimum variance or risk parity portfolios. If expected return and risks are known with certainty, a maximum sharpe ratio is good choice. The portfolio selection depends on our information and knowledge about the market. For example, MVO becomes minimum variance if expected reutrns are equal it coincides with maximum diversification if return-risk ratios are the same across assets (). It is known that all these portfolios are special cases of MVO under some conditions. Then we evaluate these allocation strategies using historical market data. This post continues to discuss some popular practices in asset allocation, namely risk parity and maximum diversification. In previous post we reviewed the basics of mean-variance optimization (MVO), and portfolios such as minimum variance and maximmum sharpe. Then backtest the monthly portfolio rebalance strategy across five portfolios: minimum-variance, maximum-Sharpe, most-diversified, risk-parity, and equal-weights. This post discusses the risk parity framework and maximum diversification portfolio.
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