Testing risk parity portfolio performance with hedge funds
1University of Oulu, Oulu Business School, Department of Finance, Finance
|Online Access:||PDF Full Text (PDF, 1.9 MB)|
|Persistent link:|| http://urn.fi/URN:NBN:fi:oulu-201604141478
|Publish Date:|| 2016-04-19
|Thesis type:||Master's thesis
Risk parity portfolios are becoming more and more popular among investors due to its slogan of being a safe shield during the bad times, especially after the global financial crisis in 2008. As Qian (2006) stated, risk parity idea enables investors to quantify the loss contribution and ensures equal risk contribution from any assets in portfolio. Therefore, risk parity is well-balanced from risk perspective and possesses the unique diversification which investors so needed during the past global financial crisis. However, Lee (2011) expressed his doubt about risk parity portfolio effectiveness as he does not believe the underlying theory of risk parity where investors do not have to put an effort to forecast returns but are predicted to generate better results than those who actually estimate expected returns.
The aim of this study is to test the effectiveness and benefit of risk parity portfolio if it had been adapted among hedge funds during the global financial crisis compared to the actual historical performances. Beside, alternative comparison portfolio methods include minimum variance portfolio and equally weighted portfolio due to its popularity and practical benefits in portfolio management industry.
The data used in this research is aggregated hedge funds stock holdings database from Charle Cao, Jeremiah Green and Jiahan Li (2014). This database is based mainly on 13_F fillings from SEC and equity returns snapshot from CRSP (Center Research in Security Prices). The observation period of hedge funds fillings is fourteen years and 6 months from March 1999 to June 2013 with quarterly frequency. Meanwhile, US market stock returns were observed on monthly basic and with additional five years earlier starting from January 1994 to June 2013. The data consists of the 13_F section fillings and time series returns of the whole pool of stocks from CRSP with December 2013.
The study emphasized that there is no single portfolio construction method could persistently deliver the best returns over time. However, its confirmed (Qian 2005) as well as (Ruban & Meles 2011) findings. Risk parity portfolios might not always be the best perfomer but there is a high possibility that these portfolios can surpass the performance of other traditional portfolios such as minimum variance, equally weighted portfolio during the bad times. This study agrees with (Chaves et al 2011), equal risk contribution portfolio is the one with the lowest volatility overall and able to deliver good and stable Sharpe Ratio during the whole observation periods. Additionally, following (Demiguel et al 2009), the study proved equally weighted portfolio is frequently among top performers over the observed period whereas the concentration issue of minimum variance portfolio was undeniable as (Clarke et al 2006).
Taken into account the drawbacks from the database and portfolio rebalancing frequency, the study suggested future researches could be conducted with yearly or even quarterly portfolio rebalancing if the database allows. Another aspect to explore regarding to risk parity concept is about risk parity portfolio properties and its relation with leverage.
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