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Annals of Operations Research

, Volume 266, Issue 1–2, pp 255–291 | Cite as

Risk minimization in multi-factor portfolios: What is the best strategy?

  • Philipp J. Kremer
  • Andreea Talmaciu
  • Sandra Paterlini
Analytical Models for Financial Modeling and Risk Management

Abstract

Exposures to risk factors, as opposed to individual securities or bonds, can lead to an ex-ante improved risk management and a more transparent and cheaper way of developing active asset allocation strategies. This paper provides an extensive analysis of eight state-of-the-art risk-minimization schemes and compares risk factor performance in a conditional performance analysis, contrasting good and bad states of the economy. The investment universe spans a total of 25 risk factors, including size, momentum, value, high profitability and low investments, from five non-overlapping regions (i.e., USA, UK, Japan, Developed Europe ex. UK and, Asia ex. Japan). Considering as investment period the interval from May 2004 to June 2015, our results show that each single factor yields positive premia in exchange for risk, which can lead to considerable underperformance and extensive recovery periods during times of crisis. The best factor investments can be found in Asia ex. Japan and the US. However, risk factor based portfolio construction across the various regions enables the investor to exploit low correlation structures, reducing the overall volatility, as well as tail- and extreme risk measures. Finally, the empirical results point towards the long-only global minimum variance portfolio, as the best risk minimization strategy.

Keywords

Risk factors Minimum risk portfolio Regularization Portfolio optimization Transaction cost 

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Copyright information

© Springer Science+Business Media New York 2017

Authors and Affiliations

  • Philipp J. Kremer
    • 1
  • Andreea Talmaciu
    • 2
  • Sandra Paterlini
    • 1
  1. 1.EBS Universität für Wirtschaft und RechtWiesbadenGermany
  2. 2.J.P. Morgan Private BankLondonUK

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