Journal of Asset Management
Vandenbroucke, J. (2016), “The role of correlation in risk profile portfolios”, Journal of Asset Management. DOI 10.1057/s41260-016-0026-3
In a nutshell
Fixed asset class combinations submit to time-varying riskiness. Specifically following the financial crisis investors have shown a growing interest in model-based strategies that aim to keep value fluctuations under control.
The current publication zooms in on two widely used techniques, which are risk parity and risk control. Both model-based strategies combine equity and bonds in a varying proportion. Risk parity targets a predefined risk contribution of, for example, equity while risk control aims to fix portfolio volatility at a predefined level.
The publication shows how both techniques imply an opposite sensitivity towards correlation between equity and bonds. While risk control decreases equity exposure in case of higher correlation, risk parity proposes the increase equity exposure when faced with the same situation. This is important information for portfolio managers and investors to understand model-based allocation changes.