The Risk Parity Principle Applied to a Corporate Bond Index
Résumé
In this paper, we apply the principle of risk parity to a corporate bond
index, an asset class so far left behind in this literature. Specically, we
rely on the Duration Times Spread (DTS) a coherent metric for bond
credit risk. We construct indexes based on sector - issuer - and bond level
using structured block correlation matrices, weights being inversely pro-
portional to DTS. Our results provide evidence that applying an Equal
Risk Contribution (ERC) principle using DTS in the index design signif-
icantly improves corporate bond index risk-adjusted returns. It appears
that the higher the granularity is, the higher will be the risk-adjusted per-
formance enhancements. More generally, the ERC application we present
seems to be a valuable trade-off between heuristic and more complex risk-
modeling based weighting schemes.