Taking the Right Course Navigating the ERC Universe
60 Pages Posted: 13 Jun 2014
Date Written: April 30, 2014
Abstract
In this study, we explore the risk parity and equal risk contribution (ERC) investment strategies and propose an interpretation of their return dynamics conditioning on the states of the market. We also evaluate risk parity against other risk-only and risk-return approaches. Finally, we combine ERC-based portfolios using the regression-based approach of Britten-Jones (1999), thus obtaining a tangency portfolio to the ERC frontier. Using the results of a back-testing exercise from January 2001 to August 2013, we conclude that this tangent portfolio dominates traditional ERC, global minimum variance, and Markowitz portfolios in terms of both risk-adjusted performance and portfolio diversification measures.
Keywords: Portfolio Optimization, Risk Parity, Equal Risk Contribution, Regression Trees
JEL Classification: G11, G15, C14
Suggested Citation: Suggested Citation