This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.

Macro Factor Risk Parity

Quantpedia

Contributor:
Quantpedia
Visit: Quantpedia

Risk and diversification are critical interests of every investor, especially when things go south since the correlations across assets tend to rise during stressful times. Therefore, in the asset allocation, the risk parity allocation is one of the key topics. Factors are commonly known as underlying sources of both risk and returns, and it is assumed that they can be utilized to achieve superior risk-adjusted returns and diversification. However, there seems to be a lack of research that would be related to the macro factors. This gap is quite striking since there is a general consent that macro factors (for example, inflation) largely influence the broad set of assets. Amato and Lohre (2020) research paper fills the gap and studies the usage of macro factors as diversifiers in asset allocation. 

The authors divide the macro factors into two groups, where the first consists of TERM, MARKET, USD, OIL and DEF (default risk), and the second group consists of CLI (a measure of output by OECD), G7.INFLATION, G7.Short.Rate and VIX. The research shows, that when the diversification matters the most, only the second group improves both the risk and returns, acting as a successful diversification during various economic regimes and particularly, during high economic uncertainty. Overall, the paper offers exciting insights into diversification and macro factors, accompanied by more complex mathematical models definitely worth looking into. 

Authors: Livia Amato and Harald Lohre

Title: Diversifying Macroeconomic Factors — For Better or for Worse

Linkhttps://papers.ssrn.com/sol3/papers.cfm?abstract_id=3730154

Abstract:

It is widely acknowledged that asset returns are driven by common sources of risk, especially in challenging times when the benefits from traditional portfolio diversification fail to realize. From a top-down perspective, investors are mostly concerned about shocks in growth or inflation that ultimately govern the pricing of broad asset classes. To this extent, we propose a natural asset allocation framework to achieve a diversified exposure to orthogonal macro risk factors and to harvest the associated long-term premia. We examine the role and usefulness of different types of macroeconomic variables, as systematic sources of risk or state variables that drive time variation in the asset returns, and compare their diversification potential across different states of the world.

Visit Quantpedia to read the full article and review supporting charts and tables:
https://quantpedia.com/macro-factor-risk-parity/

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from Quantpedia and is being posted with permission from Quantpedia. The views expressed in this material are solely those of the author and/or Quantpedia and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

trading top