The Role Of Risk Budgeting In Reserves Management

By Mendes Alfredo
2012

Risk budgeting, as a risk management concept, is a key component of the investment decision making process. It is concerned with carefully allocating a risk budget among assets or asset classes, closely monitoring changes in the portfolio or fund’s risk positioning, and timely adjusting the risk allocation to keep a portfolio or fund’s actual risk consistent with the desired level. This study has examined the extent to which MEFMI Region central banks use risk budgeting in the reserves management process. The findings show that overall the region has not yet developed an adequate risk budgeting framework. There is no a consistent risk factor analysis, i.e., a clear definition of fund (total) risk and its assignment to different risk components (assets, asset classes, portfolios, strategies or managers) of the fund´s management. This study therefore has provided an analytical framework for optimal risk allocation and monitoring across portfolio managers, portfolio strategies or portfolio asset classes, bearing in mind their correlations; where correlation-adjusted information ratio is key factor for optimal risk budgeting.
Key Words: Asset allocation, risk allocation, risk budgets, expected IR, correlation-adjusted IR, expected excess return, target tracking error