Market Screening, Risk Premia Dynamics and Optimal Portfolios

Abstract

This study investigates the relationship between real risk premia and nominal risk premia, volatilities, and portfolio allocation for equities, bonds, and Exchange Traded Funds (ETFs) over a specific period. By evaluating the impact of volatility and adjusting for inflation on risk premia for each portfolio class, we observe slight variations compared to nominal risk premia without considering inflation. The objective of the study is to optimize portfolio allocation by considering volatilities and risk premia components while capturing investors' response to changes in rolling periods. To estimate risk premia and compare the impact of inflation on selected indices, the Historical Risk Premium Model (HRPM) is utilized, focusing on nominal versus real risk premia derived from index volatilities. Additionally, different portfolio optimization approaches such as Markowitz's Mean-Variance approach, the 1/n policy approach, and the Equally weighted risk contribution (ERC) approach are employed to evaluate portfolio allocation for different types of investors. The findings reveal significant correlations between the volatilities of selected equities, bonds, and ETF indices and their respective risk premia. This is evident in the asset allocation using the mean-variance approach, which shows a trend influenced by high-risk premia and volatility components. In contrast, the 1/n policy and ERC approaches indicate minimal variation in each period for asset allocation. Therefore, volatilities play a crucial role in influencing portfolio allocations and shaping investors' response functions for each index within the asset classes.

Date of Award	Aug 2023
Original language	American English
Supervisor	GIORGIO Consigli (Supervisor)