Long-only equal risk contribution portfolios for CVaR under discrete distributions |
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Authors: | Helmut Mausser |
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Institution: | Risk Analytics, Watson Financial Services, IBM Canada , 185 Spadina Avenue, Toronto, ON, M5T 2C6 Canada. |
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Abstract: | Portfolios in which all assets contribute equally to the conditional value-at-risk (CVaR) represent an interesting variation of the popular risk parity investment strategy. This paper considers the use of convex optimization to find long-only equal risk contribution (ERC) portfolios for CVaR given a set of equally likely scenarios of asset returns. We provide second-order conic and non-linear formulations of the problem, which yields an ERC portfolio when CVaR is both positive and differentiable at the optimal solution. We identify sufficient conditions for differentiability and develop a heuristic that obtains an approximate ERC portfolio when the conditions are not satisfied. Computational tests show that the approach performs well compared to non-convex formulations that have been proposed in the literature. |
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Keywords: | Risk parity ERC portfolio CVaR Discrete distribution Second-order cone |
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