Journal of Investment Strategies

Risk.net

  • Based on symmetry arguments, we construct portfolios that achieve equal realized risk on all the principal components of the covariance matrix.
  • One particular choice corresponds to our “Agnostic Risk Parity” portfolio, which minimizes unknown-unknown risks generated by over-optimistic hedging of the different bets.
  • This allocation significantly over-performs Markowitz’ portfolios when applied to classic technical (CTA) strategies.

Markowitz’s celebrated optimal portfolio theory generally fails to deliver out-of-sample diversification. In this paper, we propose a new portfolio construction strategy based on symmetry arguments only, leading to “eigenrisk parity” portfolios that achieve equal realized risk on all the principal components of the covariance matrix. This holds true for any other definition of uncorrelated factors. We then specialize our general formula to the most agnostic case, where the indicators of future returns are assumed to be uncorrelated and of equal variance. This “agnostic risk parity” (AGP) portfolio minimizes unknown-unknown risks generated by the over-optimistic hedging of different bets. AGP is shown to fare quite well when applied to standard technical strategies such as trend following.

To continue reading...

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an indvidual account here: