Performance of risk-based asset allocation strategies

Simen Knutzen & Jens Retterholt

Student thesis: Master thesis

Abstract

This thesis measured the performance and behaviour of the most used risk-based asset allocation strategies, i.e., the global minimum variance portfolio, the equally-weighted risk contributions portfolio, the most diversi ed portfolio, and the equally-weighted portfolio. We analyzed how well these portfolios performed when re-investing returns, and to what degree they were useful as risk targeting tools. The covariance matrix estimation was applied in line with the most recent studies in this eld. To estimate the covariance matrix we used the method of shrinkage. As the covariance matrix is of great importance in the construction of the portfolios, we included two shrinkage targets to examine the impact the di erent covariance matrices had on the results. These targets matrices were chosen from the constant correlation model and the single-index model. The data subject to study were the historical components of the EURO STOXX 50 from February 1998 to March 2015. This study found that all the risk-based asset allocation strategies performed better than the market index and the equally-weighted portfolio when reinvesting returns. The results among the strategies di ered when di erent covariance matrices were used. Results obtained from the study found that the equally-weighted risk contributions portfolio was the most robust towards covariance matrix changes. Our study showed that the global minimum variance portfolio performed best among all strategies regardless of covariance matrix used when re-investing returns. The study also found the equally-weighted portfolio to be the most useful to obtain a constant risk target since this portfolio was closest to the target, and its results was insensitive to covariance matrix changes. The other strategies consistently underestimated their risk, and their risk targeting abilities were highly in uenced by the choice of covariance matrix used.

EducationsMSc in Business Administration and Management Science, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2015
Number of pages156