The Correlated Risk Parity PP

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MachineGhost
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The Correlated Risk Parity PP

Post by MachineGhost » Wed Jun 17, 2015 8:51 pm

Not sure I ever posted this in the Achilles Heel thread, but a picture is worth a thousand words they say:

[align=center][img width=800]http://s22.postimg.org/ivna7iztt/riskparity.png[/img][/align]
Last edited by MachineGhost on Mon Apr 04, 2016 8:29 pm, edited 1 time in total.
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Re: The Risk Parity PP

Post by Desert » Wed Jun 17, 2015 9:00 pm

Hmmm... interesting, but can you describe the columns a bit? 

Is the left-most column the equal risk portfolio?  The equal volatility portfolio (both)? 

If so, what is that column at the far right with the cash?

Thanks
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Re: The Risk Parity PP

Post by pugchief » Wed Jun 17, 2015 9:18 pm

This isn't that far off from the weightings I talked about in my risk parity / volatility thread, which multiple people condemned as too bond heavy (because rates have nowhere to go but up TM).

I think this makes a lot of sense vs 4x25.
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Re: The Risk Parity PP

Post by MachineGhost » Wed Jun 17, 2015 9:35 pm

Desert wrote: Is the left-most column the equal risk portfolio?  The equal volatility portfolio (both)? 

If so, what is that column at the far right with the cash?
Left is the equal risk contribution (ERC) portfolio using daily volatility for the risk metric.

And the right is the ERC portfolio scaled [down] to the 25x4 PP's level of daily volatility with the difference going into cash.
Last edited by MachineGhost on Wed Jun 17, 2015 9:43 pm, edited 1 time in total.
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Re: The Risk Parity PP

Post by MachineGhost » Wed Jun 17, 2015 9:40 pm

pugchief wrote: This isn't that far off from the weightings I talked about in my risk parity / volatility thread, which multiple people condemned as too bond heavy (because rates have nowhere to go but up TM).

I think this makes a lot of sense vs 4x25.
Just keep in mind the bond volatility does not include a peak-to-trough bear market.
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Re: The Risk Parity PP

Post by Desert » Wed Jun 17, 2015 9:45 pm

MachineGhost wrote:
Desert wrote: Is the left-most column the equal risk portfolio?  The equal volatility portfolio (both)? 

If so, what is that column at the far right with the cash?
Left is the equal risk contribution (ERC) portfolio using daily volatility for the risk metric.

And the right is the ERC portfolio scaled [down] to the 25x4 PP's level of daily volatility with the difference going into cash.
Ah, I understand now.  That's very interesting.  And what period did you use to evaluate volatility? 

Please tell me it started in ~1975, and not back in the fictional gold years....
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Re: The Risk Parity PP

Post by MachineGhost » Wed Jun 17, 2015 9:56 pm

Desert wrote: Ah, I understand now.  That's very interesting.  And what period did you use to evaluate volatility? 

Please tell me it started in ~1975, and not back in the fictional gold years....
Its not fictional!  The London Gold Pool collapsed in 1968 and gold became a free market.  Legality technicalities of any one country are irrelevant when gold is a worldwide commodity.  Besides, didn't you see all the loopholes I listed in the other thread?  And only one person ever got prosecuted under FDR's order (and I think he won anyway).  It was just a stupid law with no real enforcement other than via self-fear.  All it did was prevent gold from being legally sold here in the open by dealers, not to citizens per se.  What would be the point of writing a book talking about the coming collapse of the dollar in 1970 if you really couldn't buy gold to protect yourself?
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Re: The Risk Parity PP

Post by Desert » Wed Jun 17, 2015 10:07 pm

MachineGhost wrote:
Desert wrote: Ah, I understand now.  That's very interesting.  And what period did you use to evaluate volatility? 

Please tell me it started in ~1975, and not back in the fictional gold years....
Its not fictional!  The London Gold Pool collapsed in 1968 and gold became a free market.  Legality technicalities of any one country are irrelevant when gold is a worldwide commodity.  Besides, didn't you see all the loopholes I listed in the other thread?  And only one person ever got prosecuted under FDR's order (and I think he won anyway).  It was just a stupid law with no real enforcement other than via self-fear.  All it did was prevent gold from being legally sold here in the open by dealers, not to citizens per se.  What would be the point of writing a book talking about the coming collapse of the dollar in 1970 if you really couldn't buy gold to protect yourself?
Well, that's true if a typical investor could access the commodity.  I suppose a U.S. back-tester could convince himself that the 1971 end of the dollar peg could be a starting point.  Before that, a gold investment was equal to a cash investment.  And even after 1971, we saw a once-in-a-lifetime free market adjustment to the dollar/gold ratio.  To assume otherwise requires that you assume we could be re-pegged to the dollar (a return of the gold standard, however briefly).  So yes, I view the pre 1971 values as cash, and the most of the '70's as a once-in-a-lifetime adjustment in value.  We certainly don't want to measure returns or volatility in that special era and try to extrapolate it into the modern era; that would be very misleading, no? 
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Re: The Risk Parity PP

Post by MachineGhost » Wed Jun 17, 2015 10:21 pm

Desert wrote: Well, that's true if a typical investor could access the commodity.  I suppose a U.S. back-tester could convince himself that the 1971 end of the dollar peg could be a starting point.  Before that, a gold investment was equal to a cash investment.  And even after 1971, we saw a once-in-a-lifetime free market adjustment to the dollar/gold ratio.  To assume otherwise requires that you assume we could be re-pegged to the dollar (a return of the gold standard, however briefly).  So yes, I view the pre 1971 values as cash, and the most of the '70's as a once-in-a-lifetime adjustment in value.  We certainly don't want to measure returns or volatility in that special era and try to extrapolate it into the modern era; that would be very misleading, no?
I think you're under some kind of misapprehension that gold didn't flunctuate in U.S. dollar terms between 1968 and 1971.  So cash was hardly the same thing as gold.  Your cash bought less and less gold all the way up until 1980.

I could argue that when the 30yr bond collapses in a sovereign debt crisis under our floating exchange rate system in the near future, it will be a once in a lifetime, special era event.  Does that mean all prior history then becomes useless?

What we're really interested in with history is the extremes to get an idea of the realistic amount of risk that can be expected in the future.  Nothing more, nothing less.

And BTW anyone that owns 25% gold is not a typical investor, so its sort of a red herring to be worrying about it.  99% of investors back then would not have had a PP and if they were smart enough to have had one, they were smart enough to have figured out how to own the gold.
Last edited by MachineGhost on Wed Jun 17, 2015 10:26 pm, edited 1 time in total.
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Re: The Risk Parity PP

Post by Desert » Wed Jun 17, 2015 10:44 pm

MachineGhost wrote:
Desert wrote: Well, that's true if a typical investor could access the commodity.  I suppose a U.S. back-tester could convince himself that the 1971 end of the dollar peg could be a starting point.  Before that, a gold investment was equal to a cash investment.  And even after 1971, we saw a once-in-a-lifetime free market adjustment to the dollar/gold ratio.  To assume otherwise requires that you assume we could be re-pegged to the dollar (a return of the gold standard, however briefly).  So yes, I view the pre 1971 values as cash, and the most of the '70's as a once-in-a-lifetime adjustment in value.  We certainly don't want to measure returns or volatility in that special era and try to extrapolate it into the modern era; that would be very misleading, no?
I think you're under some kind of misapprehension that gold didn't flunctuate in U.S. dollar terms between 1968 and 1971.  So cash was hardly the same thing as gold.  Your cash bought less and less gold all the way up until 1980.

I could argue that when the 30yr bond collapses in a sovereign debt crisis under our floating exchange rate system in the near future, it will be a once in a lifetime, special era event.  Does that mean all prior history then becomes useless?

What we're really interested in with history is the extremes to get an idea of the realistic amount of risk that can be expected in the future.  Nothing more, nothing less.

And BTW anyone that owns 25% gold is not a typical investor, so its sort of a red herring to be worrying about it.  99% of investors back then would not have had a PP and if they were smart enough to have had one, they were smart enough to have figured out how to own the gold.
I'm not an expert on gold/cash ratios between 1968 and '71.  But I have seen multiple charts that look a lot like this one:
Image

I don't have numeric data for the late 60's, but I believe the real cost of gold tracked the peg pretty closely.  After the peg, you can see one of the biggest asset corrections/bubbles we've seen in our lifetimes.  That's to be expected, after a major discontinuity introduced by the reserve currency going off the gold standard. 

Look, I like what you're doing, matching volatilities.  But to ignore a major singularity like losing the dollar/gold peg, is just not rational. 

And to answer your question:  yes, if we had a major default on U.S. treasuries, the previous history would be essentially worthless.  Survivorship bias is powerful.  We're not looking at the history of German bonds here, for a reason.  We don't stare too deeply at the Japanese stock market history when contemplating equity returns.  We look at U.S.-centric returns, when evaluating investment strategies.  And to ignore the complete change in monetary policy in regard to gold in 1971-1975 is just foolish.  Even starting in 1975 is a bit unrealistic.  For any gold-containing portfolios, the furthest back I can talk myself into is 1975.  Further than that, and we're talking fool's gold. 
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Re: The Risk Parity PP

Post by MachineGhost » Wed Jun 17, 2015 11:13 pm

Desert wrote: Look, I like what you're doing, matching volatilities.  But to ignore a major singularity like losing the dollar/gold peg, is just not rational. 
I'm not ignoring it.  I want to capture it in the data.  It's a real event that happened.  I don't understand why you would want to sweep it under the rug?  Are you afraid gold will never be that volatile again and you'll underweight it in your portfolio?  Then why only a 10% allocation?  Look, this is what gold did before and after the pool collapse / depegging:

Code: Select all

1958	0.00%
1959	0.00%
1960	3.55%
1961	-2.74%
1962	-0.42%
1963	-0.28%
1964	0.28%
1965	0.42%
1966	-0.28%
1967	0.28%
1968	22.54%
1969	-5.75%
1970	-5.12%
1971	14.65%
1972	43.14%
1973	75.83%
1974	66.15%
It's not even that significant since the gains and losses between 1968.25-1971.75 were easily trumped by what came later including very recently with the 40% peak-to-trough drawdown.
Last edited by MachineGhost on Wed Jun 17, 2015 11:16 pm, edited 1 time in total.
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Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet.  I should not be considered as legally permitted to render such advice!
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Re: The Risk Parity PP

Post by D1984 » Wed Jun 17, 2015 11:56 pm

MachineGhost wrote:
Desert wrote: Look, I like what you're doing, matching volatilities.  But to ignore a major singularity like losing the dollar/gold peg, is just not rational. 
I'm not ignoring it.  I want to capture it in the data.  It's a real event that happened.  I don't understand why you would want to sweep it under the rug?  Are you afraid gold will never be that volatile again and you'll underweight it in your portfolio?  Then why only a 10% allocation?  Look, this is what gold did before and after the pool collapse / depegging:

Code: Select all

1958	0.00%
1959	0.00%
1960	3.55%
1961	-2.74%
1962	-0.42%
1963	-0.28%
1964	0.28%
1965	0.42%
1966	-0.28%
1967	0.28%
1968	22.54%
1969	-5.75%
1970	-5.12%
1971	14.65%
1972	43.14%
1973	75.83%
1974	66.15%
It's not even that significant since the gains and losses between 1968.25-1971.75 were easily trumped by what came later including very recently with the 40% peak-to-trough drawdown.
MG,

Are your gold prices from LBMA? For 1970, they show gold closing at $37.38 on the PM closing fix of 12-31-1970; given that it closed 1969 at around $35.20 (after opening the year at just under $42....around $41.90 IIRC) shouldn't the table you posted show a gain of 6.19% for 1970 and a loss of 15.98% or 15.99% for 1969? The LBMA London price was the "free market" price during this time period, was it not?
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