The Properties of Equally Weighted Risk Contribution Portfolios

Abstract

1. Sébastien Maillard 1. is a quantitative analyst at Lyxor AM in Paris, France. (sebastien.maillard{at}lyxor.com) 2. Thierry Roncalli 1. is a professor of finance at the University of Evry and the head of Research and Development at Lyxor AM in Paris, France. (thierry.roncalli{at}lyxor.com) 3. Jérôme Teïletche 1. is a professor of finance at the University of Paris Dauphine and the head of Systematic Investment Strategies at Lombard Odier in Geneva, Switzerland. (jerome.teiletche{at}dauphine.fr) <!-- --> 1. To order reprints of this article, please contact Dewey Palmieri at dpalmieri{at}iijournals.com or 212-224-3675. Minimum-variance portfolios and equally weighted portfolios have recently prompted great interest from both academic researchers and market practitioners because their construction does not rely on expected average returns and, therefore, is assumed to be robust. In this article, the authors consider a related approach in which the risk contribution from each portfolio component is made equal, maximizing the diversification of risk, at least, on an ex ante basis. Roughly speaking, the resulting portfolio is similar to a minimum-variance portfolio subject to a diversification constraint on the weights of its components. The authors derive the theoretical properties of such a portfolio and show that its volatility is located between those of minimum-variance and equally weighted portfolios. Empirical applications confirm that ranking. Equally weighted risk contribution portfolios appear to be an attractive alternative to minimum-variance and equally weighted portfolios and, therefore, could be considered a good trade-off between the two approaches in terms of absolute risk level, risk budgeting, and diversification. TOPICS: [Portfolio construction][1], [analysis of individual factors/risk premia][2], [volatility measures][3] [1]: https://www.pm-research.com/topic/portfolio-construction [2]: https://www.pm-research.com/topic/analysis-individual-factorsrisk-premia [3]: https://www.pm-research.com/topic/volatility-measures