Risk budget portfolios with convex Non-negative Matrix Factorization

Bruno Spilak; Wolfgang Karl Härdle

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arXiv · 2204.02757

Risk budget portfolios with convex Non-negative Matrix Factorization

Bruno Spilak·Wolfgang Karl Härdle

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Abstract

We propose a portfolio allocation method based on risk factor budgeting using convex Nonnegative Matrix Factorization (NMF). Unlike classical factor analysis, PCA, or ICA, NMF ensures positive factor loadings to obtain interpretable long-only portfolios. As the NMF factors represent separate sources of risk, they have a quasi-diagonal correlation matrix, promoting diversified portfolio allocations. We evaluate our method in the context of volatility targeting on two long-only global portfolios of cryptocurrencies and traditional assets. Our method outperforms classical portfolio allocations regarding diversification and presents a better risk profile than hierarchical risk parity (HRP). We assess the robustness of our findings using Monte Carlo simulation.

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Bruno Spilak, Wolfgang Karl Härdle. 2022-04-06. Risk budget portfolios with convex Non-negative Matrix Factorization. https://arxiv.org/abs/2204.02757

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