Robust Risk Parity and Covered Call Optimization

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The proposed research will focus on the development of mathematical models and algorithms for financial investment design. We consider investment (asset allocation) frameworks based on risk parity optimization, index tracking, and covered call overlays. Risk parity is a relatively new approach that uses mathematical optimization to create investment decisions where risk contributions from individual assets are equal which readily results in diversified portfolios unlike the use of mean-variance optimization. However, little attention has been given to determine how robust risk parity models are. We have found that nave approaches for risk parity optimization can exhibit considerable sensitivity to parameter estimations. The development of a robust formulation of risk parity optimization is a major goal of our research. We will incorporate expected returns and short selling to form general risk-return risk parity-based models. The benefit is that an investor will have the ability to better trade-off return and degree of risk parity in constructing investment strategies.******Portfolio indexing is a passive investing strategy that aims to replicate the risk and return profile of a broad market index such as the Sstimations are then required, which we will mitigate estimation error by considering robust optimization.******Option overlays such as covered call writing has emerged ras an effective method of enhancing returns of a portfolio. This is where an investor will sell call options on the assets of her portfolio. One limitation of this strategy is that call options are sold in correspondence to the entire position of an asset. Also, covered call overlays also assume that the investment portfolio is known prior to selling the call options. We seek to develop optimization models to capture a generalized cover call problem where both investment allocation decisions and covered call selling are done simultaneously under uncertainty in asset prices. As a special case, simultaneous risk parity and covered call optimization will be developed. ******The results from the proposed research will extend the field of financial optimization and have significant practical benefits in the financial investment industry which is an important sector of the Canadian economy. The training of HQP in the research program will prepare them to engage in industry as quantitative financial professionals adding strength to Canada's vibrant financial industry.********