Relative Risk Tolerace & Absolute Risk Tolerance

C

Chuckrox8

New member
Joined
Jul 17, 2008
Messages
0
Reaction score
0
I’m having trouble understanding the differentiation between the two in the context of the three portfolio rebalancing strategies: Buy & Hold, Constant Mix, and CPPI. Could someone shed some light on the differences between the two for each of the rebalancing methods?
Thanks!
 
all derive from the same formula :
allocation to equity = M($portfolio - $floor)
B&H M=1 risk tolerance is going up as $ portfolio is going up since you allocate more % to equity
constant mix M < 1 ( and normaly floor = 0 ) risk tolerance is constant since always the same % to equity
CPPI M > 1 risk tolerance is going up ( more quickly than B&H ) since when you have more money you dont just hold the portfolio has is like B&H you actually buy more equity.
 
With CM, we know that we’ll hold a certain proportion of equities/fixed income – say, 60/40 – at all times. That’s an absolute.
With CPPI, though, our risk tolerance varies and is relative to the total value of our portfolio. As portfolio value increases, our risk tolerance increases along with allocation to equities. And vice versa.
With Buy-and-Hold, however, I believe that our risk tolerance is static and never changes since we’re passive in the portfolio and do not make trades to alter the asset allocation to equities.
 
B&H from CFAi
The implication of using this strategy is that the investor’s risk tolerance is positively related to wealth and stock market returns. Risk tolerance is zero if the value of stocks declines to zero.
(Institute 93)
Institute, CFA. Level III 2013 Volume 6 Portfolio: Execution, Evaluation and Attribution, and Global Investment Performance Standards. John Wiley & Sons P&T, 6/18/2012. <vbk:9781937537388#page(93)>.
 
CPPI
CPPI is consistent with a higher tolerance for risk than a buy-and-hold strategy (when the cushion is positive), because the investor is holding a larger multiple of the cushion in stocks. Whereas a buy-and-hold strategy is do-nothing, CPPI is dynamic, requiring a manager to sell shares as stock values decline and buy shares as stock val- ues rise
(Institute 94)
Institute, CFA. Level III 2013 Volume 6 Portfolio: Execution, Evaluation and Attribution, and Global Investment Performance Standards. John Wiley & Sons P&T, 6/18/2012. <vbk:9781937537388#page(94)>.
 
Constant mix
A constant-mix strategy is consistent with a risk tolerance that varies proportion- ately with wealth.18 An investor with such risk tolerance desires to hold stocks at all levels of wealth.
(Institute 93)
Institute, CFA. Level III 2013 Volume 6 Portfolio: Execution, Evaluation and Attribution, and Global Investment Performance Standards. John Wiley & Sons P&T, 6/18/2012. <vbk:9781937537388#page(93)>.
 
You must log in or register to reply here.
Back
Top