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Article

Extending the Risk Parity Approach to Higher Moments: Is There Any Value Added?

Eduard Baitinger, André Dragosch and Anastasia Topalova
The Journal of Portfolio Management Winter 2017, 43 (2) 24-36; DOI: https://doi.org/10.3905/jpm.2017.43.2.024
Eduard Baitinger
is head of asset allocation at FERI Trust GmbH in Bad Homburg, Germany.
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  • For correspondence: eduard.baitinger@feri.de
André Dragosch
is an asset allocation analyst at FERI Trust GmbH in Bad Homburg, Germany.
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  • For correspondence: andre.dragosch@feri.de
Anastasia Topalova
is a senior asset allocation analyst at FERI Trust GmbH in Bad Homburg, Germany.
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  • For correspondence: anastasia.topalova@feri.de
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Abstract

The popular risk parity approach is based on volatility as the sole risk measure and therefore lacks the consideration of tail risk. This fact makes risk parity portfolios vulnerable to tail events. In this article, the authors address this issue by showing how higher-risk-moment terms can be consistently incorporated into risk parity optimization. In addition, they present a novel optimization approach in which optimal moment weightings (preferences) in the risk parity optimization are imputed from the data. In a broad-based empirical out-of-sample study and simulation analysis, the authors find superior performance of higher-moment risk parity portfolios when the underlying data exhibit significant higher moments and co-moments. According to the authors, this makes higher-moment risk parity portfolios ideal candidates for worst-case regimes.

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The Journal of Portfolio Management: 43 (2)
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Vol. 43, Issue 2
Winter 2017
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Extending the Risk Parity Approach to Higher Moments: Is There Any Value Added?
Eduard Baitinger, André Dragosch, Anastasia Topalova
The Journal of Portfolio Management Jan 2017, 43 (2) 24-36; DOI: 10.3905/jpm.2017.43.2.024

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Extending the Risk Parity Approach to Higher Moments: Is There Any Value Added?
Eduard Baitinger, André Dragosch, Anastasia Topalova
The Journal of Portfolio Management Jan 2017, 43 (2) 24-36; DOI: 10.3905/jpm.2017.43.2.024
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  • Article
    • Abstract
    • RISK PARITY AND HIGHER MOMENTS
    • DATASETS AND EMPIRICAL STUDY SETUP
    • EMPIRICAL EVIDENCE
    • SIMULATION STUDY
    • CONCLUDING REMARKS
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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