Second Order Risk
Portfolio Management
2009-08-19 v1 Risk Management
Abstract
Managing a portfolio to a risk model can tilt the portfolio toward weaknesses of the model. As a result, the optimized portfolio acquires downside exposure to uncertainty in the model itself, what we call "second order risk." We propose a risk measure that accounts for this bias. Studies of real portfolios, in asset-by-asset and factor model contexts, demonstrate that second order risk contributes significantly to realized volatility, and that the proposed measure accurately forecasts the out-of-sample behavior of optimized portfolios.
Keywords
Cite
@article{arxiv.0908.2455,
title = {Second Order Risk},
author = {Peter G. Shepard},
journal= {arXiv preprint arXiv:0908.2455},
year = {2009}
}
Comments
23 pages, 5 figures