Journal of Investment Strategies
ISSN:
2047-1238 (print)
2047-1246 (online)
Editor-in-chief: Ali Hirsa
The Bayesian roots of risk balancing
Hakan Kaya
Abstract
ABSTRACT
The authors show that log regularization leads to a fund-separation-type property, where the optimal solution lies between an unconstrained mean-risk-optimized portfolio and a risk-balanced portfolio. They also demonstrate in a Bayesian framework that these log regularizations are actually equivalent to putting prior distributions on the optimal portfolio weights. They provide numerical examples of a typical institutional asset universe and, finally, prove that there are efficient risk-parity portfolios that do not necessarily satisfy equal Sharpe and constant correlation conditions, which have been widely misunderstood to be the only efficiency conditions for risk-parity portfolios in the industry.
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Copyright Infopro Digital Limited. All rights reserved.
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