Introduction to risk parity and budgeting (Q2847378)

It is well known that mean-variance optimization in the spirit of Markowitz is very sensitive to the input parameters used. In particular, one has to be careful with the mean rates of return, which are notoriously difficult to estimate from historical data. As a way out, regularization techniques have been proposed to limit the impact of estimation errors.NEWLINENEWLINEIn the present book, the author advocates ``risk-parity budgeting'' as a heuristic method to obtain ``less aggressive parameters''. Here, the idea is to construct portfolios for which each underlying asset contributes the same risk, i.e., to weigh assets equally in terms of risks rather than portfolio proportions. Then, the resulting portfolios focus on risk management alone, whereas expected returns are disregarded.NEWLINENEWLINEThe author has organized this material as follows. In a first part, he presents modern portfolio theory and analyzes risk-budgeting from a theoretical point of view. In a second part, he then goes on to show how to apply this approach to various asset classes. Finally, the book also contains a technical appendix outlining the mathematical tools used in the body of the text, and a number of tutorial exercises, for which solutions are provided on the author's homepage.