The Study On Aplication Of Risk Budgeting In Core-Satellite Portfolio Management

Risk budgeting is a new idea for risk management following the VaR riskmanagement method. As risk management is more and more accounted of, core-satelliteportfolio management approach is widely used in investment practice amonginstitutional investors inside and outside the country because it bands the passive andactive investment strategies together, and possesses the advantages of passive strategy'slow cost, low risk, stable long term return and active strategy's chance to earn excessreturn. On the other hand, with the appearance of risk budgeting, the thought of lookingon the risk as scarce resource, and improving investment performance by effective riskallocation have gone deep into investors' heart. Under this trend, it is of importanttheoretical and practical meaning to introduce risk budgeting into core-satellite portfoliomanagement and investigate the application of risk budgeting in core-satellite portfoliomanagement.This paper studies the application of risk budgeting in core-satellite portfoliomanagement from two aspects of active risk budgeting and systematic risk budgeting.We investigate the application of active risk budgeting in satellite portfolio managementby studying the problems of managers' selection, active risk budgeting approach,manager's portfolio decision under active risk budgeting and the impact of active riskbudgeting on manager's effort level and investor's contract design; as portfolioinsurance is a typical mode of systematic risk budgeting, we also investigate theapplication of portfolio insurance in core portfolio management by melting the VaRdynamic risk budgeting into portfolio insurance, providing VaR-based portfolioinsurance(VBPI), comparing its relative performance with respect to buy and holdstrategy, option-based portfolio insurance and constant proportion portfolio insurancestrategy, and the effectiveness of VaR-based portfolio insurance strategy under differentmodel of risky asset, etc.Firstly, we discuss the application of active risk budgeting in satellite portfoliomanagement. 1) It is a common method to choose managers by evaluating managers'historical performance. By introducing relative efficiency ratio-ηcoefficient, it impro- ves the benchmark-efficient frontier methodology developed by Matthew and Richard,and be used to managers' performance evaluation and managers' selection, the resultshow that it is consistent with the approach of information ratio which is often used inpractice, and also reliable. 2) On the base of managers' selection, the superiority ofactive risk budgeting under principal-agent framework with respect to that withoutprincipal-agent relationship is discussed, and the active risk budgeting model underprincipal-agent framework is built, and then the impact of the two active risk budgetingapproach on investment performance are compared by empirical analysis. We find thatthe total active return resulting from active risk budgeting under principal-agentframework is generally higher than that without consideration of principal-agentrelationship.3) we build portfolio decision model under active risk budgeting frameworkby decomposing active risk budgeting into gross budgeting and structural budgeting,and solving the model when the benchmark is efficient and non efficient, respectively,then analyzing the property, in detail, of optimal investment decision under the twodifferent conditions. The results show that: the efficiency of portfolio decision lies onthe efficiency of benchmark completely; when benchmark is not efficient, structuralbudgeting determine the structure of portfolio, while gross budgeting determine thedegree which optimal portfolio deviate from benchmark; small beta in structuralbudgeting actually hedge the benchmark risk effectively, so it conduces to improve thetotal return under the same total risk. 4) We introduce active risk budgeting intodelegated portfolio management, and investigate the impact of active risk budgeting onmanager's effort level and investor's contract designing under moral hazard framework.The results show that: manager's effort level under active risk budgeting is always lessthan that of without active risk budgeting regardless of whether manager's effort level isobservable or not, but with the increase of active risk budgeting level, the effortmanager spent presents an increasing trend; while active risk budgeting has less impacton investor's contract designing, under the circumstance of no moral hazard, the firstbest contract sharing coefficient is still optimal under active risk budgeting.Secondly, we discuss the application of portfolio insurance in core portfoliomanagement. 1) We propose VaR-based portfolio insurance strategy and provide acomprehensive analysis of its hedging effectiveness by comparing with buy and holdstrategy, option-based portfolio insurance and constant proportion portfolio insurance strategy. The result show that the VaR-based portfolio insurance (VBPI) strategygenerally demonstrates a high degree of portfolio protection as long as the portfolios arenot rebalanced too frequently, while the OBPI and CPPI strategy are even worse than noinsurance at all in terms of floor protection when transaction costs are present. The threeinsurance strategies are able to limit the downward risk while retaining some upsidereturns, in addition, the VBPI strategy performs better than CPPI and OBPI in portfoliovalue protection and upside return capturing. 2) Considering the character that the riskyasset price could present jumps, we investigate the effectiveness of VBPI strategy whenrisky asset price follows jump-diffusion process, and find that it can improveperformance of the VBPI strategy by choosing jump-diffusion model when investmentperiod is relatively long. 3) Under the Black&Scholes model framework, we derive theguarantee pricing formula based on CPPI strategy, compare the real guarantee fee withthat model predicts, and find that the real guarantee fees of principal-protected fund inChina are a little higher than the model predict, which can partly explain the stagnationof principal-protected fund in China.