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Inter-temporal risk parity: A constant volatility framework for equities and other as
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Inter-temporal risk parity: A constant volatility framework for equities and other as

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Inter-temporal risk parity: A constant volatility framework for equities and other as


10 January 2014, BNP Paribas Asset Management, 14 rue Bergère, 75009 Paris, France

We show that there is not just onebut several effects explaining the increased Sharpe ratio in portfolios managed to target inter-temporal risk parity and to discuss their relative importanceVolatility clustering and the negative correlation between volatility and returns are the two most important factorsIn a world of normal distributed returnswhere volatility is constant and thus the strategy is obsoletewe show that before transaction coststhe strategy does not destroy value with Sharpe ratio and drawdowns similar to those from a buy and hold strategy.

In the second part of the paper we look at actual historical asset class return distributionsWe discuss the problem of forecasting volatility which, as discussed by Hallerbach [2012], should also be of great importanceWe find that short-term volatility models with neither assumptions for the long-term average volatility levelnor regime switchingappear to achieve a superior control of volatility expost
and the most successful smoothing of risk as well as the larger improvement in the Sharpe ratio.
In particularwe show the superiority of the I-GARCH model in forecasting equity volatility and
control for volatility ex-post.
Using I-GARCH modelswe show that the application of an inter-temporal risk parity strategy for
equities does result in an improvement in the Sharpe ratio and reduction in portfolio drawdownsThe
results are better 
for emerging equities than for developed equitiesWhen applying the strategy to
other asset classes we also find a large improvement in the Sharpe ratio of high yield corporate bonds
However the improvement of the Sharpe ratio is less evident for commoditiesinvestment grade
corporate bonds 
or government bonds
what is the Relationship between returns and volatility regimes ?

I am not able to understand it.Can anyone explain?


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