Risk Budgeting and Tail Risk for Asset Allocation

Summary

The question challenges the use of return standard deviation as the sole basis for allocating capital across uncorrelated assets. It asks what principles might support equal weights, growth-based weights, or another allocation rule when conventional mean-variance methods seem unsuitable.

The answer points to risk budgeting, a framework that assigns portions of portfolio risk to assets, and identifies risk parity as a closely related approach. It also mentions equal risk contribution methods that use tail-risk measures rather than variance. These ideas offer alternatives for defining and distributing risk, but the document provides no formulas, examples, empirical comparisons, or guidance on selecting a measure. It therefore introduces candidate frameworks without establishing which allocation is preferable or how assumptions about expected returns, dependence, and tail behavior should affect implementation.

Key ideas

• Risk budgeting allocates portfolio risk across assets rather than relying only on capital weights.
• Risk parity is closely related to risk budgeting and seeks balanced risk contributions.
• Equal risk contribution methods can be formulated with tail-risk measures instead of variance.
• The document names alternatives but gives no allocation procedure or evidence for choosing among them.

Tags

# What are non-variance (non Markowitz) based theories of capital allocation between non-correlated assets?


# What are non-variance (non Markowitz) based theories of capital allocation between non-correlated assets?












A large amount of literature in finance accepts the standard deviation in return as if it were an accurate measure of "risk."

What are some other financial theories for how to allocate capital between assets that are not correlated? What principles would lead to an equal, cagr, or some other weighting?

Using sigma is arbitrary and also 70 years old. Are there other models for how to allocate between non-correlated assets?

## Answer by RWP - Down by the Bay (score 1)

https://quant.stackexchange.com/a/53143

Risk Budgeting, to which Risk Parity is closely related.

Related to that: Risk Parity / Equal Risk Contribution with Tail Risk Measures

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.