tag:blogger.com,1999:blog-11027528911364475.comments2015-04-26T01:32:31.503-07:00EconomPicJakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comBlogger4153125tag:blogger.com,1999:blog-11027528911364475.post-89021474058933119142015-04-25T22:26:40.792-07:002015-04-25T22:26:40.792-07:00Haha... thought about putting it in log scale, but...Haha... thought about putting it in log scale, but Hussman stand alone / momentum returns (the first two charts) looked off as the returns were never strong enough to require it. As for nominal / real, that's fine but requires another step of pulling in inflation for something I don't view as necessary (especially in this regime). I'll leave the incorporation of ShadowStats data for Zerohedge. Thanks for the feedback.Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-39920981951457693342015-04-25T18:25:12.235-07:002015-04-25T18:25:12.235-07:00Hey - I'm happy to see econompic revived but r...Hey - I'm happy to see econompic revived but rather than go all fawning on that, I have to be a smart-ass :-). Years of reading dshort creates instant reactions when I see graphs like these, specifically, shouldn't it be in real total returns, and shouldn't it also be on a log scale? Then just to be a complete smart-ass, population adjust it and finish off by mockingly comparing a version where shadowstats is subbed in for CPI for inflation adjustment. Okay, maybe not the last two. Cheers!Fastsquatchhttp://www.blogger.com/profile/12368648851858425928noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-22072087611484970552015-04-25T13:37:14.333-07:002015-04-25T13:37:14.333-07:00Great example of the power of dual momentum!
JLGreat example of the power of dual momentum!<br /><br />JLjlivermorenoreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-75928463616050517422015-04-23T10:01:04.658-07:002015-04-23T10:01:04.658-07:00You as well.You as well.Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-24700813278862920572015-04-23T09:11:38.273-07:002015-04-23T09:11:38.273-07:00We are comparing asset allocation schemes with the...We are comparing asset allocation schemes with the classic fully invested constraint ie. 100% invested (0-100% in stocks and the remaining in bonds) not portfolios with the same level of risks where you leverage.<br /><br />Btw sharpe ratio would still be higher for the risk parity portfolio vs the classic allocation in the above example.<br /><br />Anyway thanks for the discussion.pcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-3267125758531207492015-04-23T08:14:46.447-07:002015-04-23T08:14:46.447-07:00With all due respect, the following statement is i...With all due respect, the following statement is incorrect "As an extreme case if correlation goes up to 1 and equity lose more than bonds as pretty common, you are much better off with a risk parity allocation (say 10% equity, 90% bonds) than a classic 60%equity/40%bond." <br /><br />You are mistaking returns with Sharpe ratio (i.e. excess return per unit of risk). For an apples to apples comparison you need to either:<br /><br />A) lever up the 10% stock / 90% bond portfolio<br />B) water down the 60% stock / 40% bond portfolio<br /><br />So that they are equal risk to one another. Assuming the 10/90 portfolio is 3x less risk than the 60/40 portfolio, the comparison is either:<br /><br />A) 30 bond/270 stock vs. the 60 bond/40 stock<br />B) 10 bond/90 stock vs. a 20 bond/13 stock/67 cash<br /><br />If correlations are literally 1, then you are better off with either stocks or bonds on a stand-alone basis... allocating to whichever has the higher Sharpe.Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-64382464484041336042015-04-23T05:59:05.150-07:002015-04-23T05:59:05.150-07:00Your comments are not relevant to my main point wh...Your comments are not relevant to my main point which is that you can't say that a risk parity asset allocation is negatively affected by an increase in cross-asset correlation MORE than any other portfolio optimization algorithm.<br /><br />To put it simply, if both stocks and bonds are going down as usual when you see an increase in correlation, you are losing money in all asset allocation portfolios and you can't predict that the risk parity is going to lose more ex-ante as the result is driven by actual weights.<br /><br />As an extreme case if correlation goes up to 1 and equity lose more than bonds as pretty common, you are much better off with a risk parity allocation (say 10% equity, 90% bonds) than a classic 60%equity/40%bond.pcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-79227604527239919652015-04-22T11:52:27.769-07:002015-04-22T11:52:27.769-07:00Incorrect on both parts:
1) you aren't necess...Incorrect on both parts:<br /><br />1) you aren't necessarily forced to underweight anything. You can simply add the asset class (i.e. a 100% stock allocation could become a 100% stock / 100% bond allocation if using long bonds instead which are about the same risk as stocks)<br /><br />2) A Sharpe ratio doesn't change with leverage (the slope between the risk free rate and the risk/return figure for the unlevered version is the Sharpe ratio), thus a 25% stock / 75% bond allocation has the same Sharpe ratio as a 30/90, 40/120, or 50/150 portfolioJakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-55135969224964627982015-04-22T11:40:10.506-07:002015-04-22T11:40:10.506-07:00Risk parit is doing just the opposite by underweig...Risk parit is doing just the opposite by underweighting asset classes with higher correlations. Regarding your example it doesn't make much sense to me as you are comparing a non leveraged portfolio with a leveraged one...pcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-62638297258791380982015-04-22T10:49:56.905-07:002015-04-22T10:49:56.905-07:00I disagree with that statement. A large shift in c...I disagree with that statement. A large shift in correlation will impact investment strategies with higher allocations to the correlating asset than strategies with smaller allocations. <br /><br />Example... what would be impacted more by a shift in correlation (all else equal):<br /><br />A) a 60% stock / 40% bond allocation<br />B) a 60% stock / 180% bond allocation<br />Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-82256008798616716322015-04-22T09:54:08.416-07:002015-04-22T09:54:08.416-07:00Therefore we cannot conclude that an increase in c...Therefore we cannot conclude that an increase in correlation among stocks and bonds will negatively affect risk parity allocation more than any other asset allocation schemes.pcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-88831883773727427102015-04-22T09:46:58.148-07:002015-04-22T09:46:58.148-07:00Thanks for the comments!Thanks for the comments!Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-24811525401410681302015-04-22T09:46:44.736-07:002015-04-22T09:46:44.736-07:00Absolutely... but it has been a material driver of...Absolutely... but it has been a material driver of the strong performance of risk parity.Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-59244023820764041022015-04-22T09:29:41.677-07:002015-04-22T09:29:41.677-07:00Jake, I do get your main point...I was trying to f...Jake, I do get your main point...I was trying to further understand what the formula is actually proving.<br /><br />As such your point that a negative correlation makes it much more likely that an allocation to bonds is much more likely to add value if A and B holds true in general not just for risk parity.pcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-60141606438269228932015-04-22T09:10:21.230-07:002015-04-22T09:10:21.230-07:00The formula just says that at some level, adding t...The formula just says that at some level, adding the new asset class improves the sharpe. The point was simply that a negative correlation makes it much more likely that an allocation to bonds (via risk parity) is much more likely to add value if:<br /><br />A) Sharpe is higher<br />B) Correlation is lowerJakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-47235823097678683242015-04-22T09:06:45.858-07:002015-04-22T09:06:45.858-07:00In my understanding the formula is referring to th...In my understanding the formula is referring to the general case of adding a new asset class to an already existing portfolio without mentioning any particular portfolio optimization scheme.<br /><br />Are you then saying that the formula holds true for risk parity only?pcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-59570293024932517472015-04-22T08:59:05.046-07:002015-04-22T08:59:05.046-07:00In your example, I calculate an optimal allocation...In your example, I calculate an optimal allocation of 98% current portfolio, 2% new portfolio - improving the Sharpe ratio from 1.0 to 1.005 (0.97% return and 0.965% risk). Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-1335089454200978462015-04-22T08:34:21.116-07:002015-04-22T08:34:21.116-07:00Current port ret: 1%
Current port vola: 1%
Current...Current port ret: 1%<br />Current port vola: 1%<br />Current port sharpe: 1<br />Current port weight: 90%<br /><br />New AC ret: -0.5%<br />New AC vola: 5%<br />New AC sharpe: -0.1<br />New AC weight: 10%<br /><br />Corr CurrentPort-NewAC: -0.2<br /><br />Test: NewACSharpe > CurrentPortSharpe*Corr<br /><br />Test is TRUE bat the Sharpe ratio for the new portfolio is actually 0.91 (lower than the CurrentPortSharpe of 1).<br /><br />It's much easier with the Excel file I put together...free to request it via email if not clear the above.<br /><br />Paolopcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-17087591811651670382015-04-22T08:18:53.945-07:002015-04-22T08:18:53.945-07:00Can you provide an example?Can you provide an example?Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-45598872730650068372015-04-22T08:00:44.793-07:002015-04-22T08:00:44.793-07:00Looks like the formula for determining whether a n...Looks like the formula for determining whether a new allocation improves a Sharpe ratio is more a rule of thumb rather than mathematically correct according to a couple of simple numerical simulations I run...pcavatorehttp://www.blogger.com/profile/15679084215057129073noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-87163853990520866552015-04-19T16:37:46.795-07:002015-04-19T16:37:46.795-07:00Nope. Just my error. Thanks for the help!Nope. Just my error. Thanks for the help!Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-18894634395495890142015-04-19T16:06:36.930-07:002015-04-19T16:06:36.930-07:00excellent article. However dividend yields in 1958...excellent article. However dividend yields in 1958 went below TBonds not above. Have I missed something?Manolohttp://www.blogger.com/profile/12302480551714003021noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-72651815333964064862015-04-10T07:24:57.826-07:002015-04-10T07:24:57.826-07:00And finally... the results are bullshit. So very s...And finally... the results are bullshit. So very similar to most smart beta backtests.Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-77331550584724770982015-04-10T07:23:52.450-07:002015-04-10T07:23:52.450-07:00Though some of this issue is cushioned by the fact...Though some of this issue is cushioned by the fact that one year (smoothed) GDP and the numbers are rarely close. Only 14 "switches" in 38 years.Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.comtag:blogger.com,1999:blog-11027528911364475.post-39075310075837114952015-04-10T07:16:01.287-07:002015-04-10T07:16:01.287-07:00I've actually been looking for that time serie...I've actually been looking for that time series myself. Lagged it (so for example, using Q4 2014 GDP data for the 3/31/15 allocation), but obvious issues in the backtest when revisions occur. Jakehttp://www.blogger.com/profile/07946497592651234440noreply@blogger.com