Risk Parity Investing
Professor Hanno Lustig
Fall 2014 firstname.lastname@example.org Due on November 4 in the dropbox before class. You can work in groups of up to 5 students. Please submit the spreadsheet with your computations as well as a separate write-up. (Two files.)
In data_ps_1.xls, the worksheet labeled raw returns lists the index returns for different Barclays bond indices and for the VW-CRSP stock market index; the spreadsheet labeled market_caps lists the total market capitalization of these different categories. We divide these assets into three categories: bonds, credit and stocks. The bond category consists of the Barclays U.S.
Treasury (LHUSTRY) and the Barclays U.S. Aggregates Government Related indices (LHUSAGR). The credit category contains all of the other Barclays bond indices. The stock index is the CRSP-VW index for all stocks traded on the NYSE, Amex and Nasdaq.
1) We start by running a horse race between different investment strategies: a) Market: Compute the value-weighted return for the market (i.e. for all three categories together). Please report the annualized Sharpe ratio.
b) Unlevered Risk Parity Strategy (URP): Compute the volatility of excess returns for each category using a three-year rolling window. Set the portfolio weight at t for each category equal to the inverse of the volatility at t-1. Rescale the portfolio weights so they sum to one.
Please report the annualized Sharpe ratio.
c) Levered Risk Parity Strategy…