Asset Allocation Taking into Account the Time Lag of Volatility Forecasting

Striving for efficient asset allocation investors usually have limited risk bearingability. This results in an upper limit for their portfolio volatility that must not be exceeded.Ensuring compliance with this risk limit at any point in time is essentially complicated bytwo factors: First, portfolio volatility permanently changes over time. Second, there is aconsiderable time lag between two consecutive estimations of portfolio volatility due to arestricted capacity of the employed technical resources as well as a fixed forecast horizon.This can result in a (considerable) inaccuracy with regard to future volatility which isusually accompanied either by a violation of the risk limit or by a suboptimal assetallocation yielding less than actually achievable return. In order to contribute to theprevention of these drawbacks, this paper focuses on the second factor for forecastinginaccuracy and presents the so-called Risk-at-Risk approach. This approach allows for theconsideration of the time lag with respect to volatility forecasting. Its integration into assetallocation facilitates the maximisation of return while simultaneously ensuring compliancewith the predefined risk limit with utmost probability.[...]