Implementing optimal risk budgeting - Managing uncertainty of alpha.

Risk budgeting has become a buzzword. While there may be no generally accep ted definition or approaches for implementation, the underlying concept of risk budgeting remains sound and relevant. Defining risk as "uncertainty of alpha," the authors argue that successful implementation of risk budgeting requires assessment of the quality of one's information under uncertainty (which the authors define as information risks), as well as other statistic al risk measurement. Using a global asset allocation portfolio as an exampl e, the authors introduce a simple optimal risk budgeting tool. With informa tion risks, investment views, and total risk budget as inputs, the framewor k presented provides the optimal combination of information advantage so th at the allocation of risks across strategies and assets is consistent with a manager's assessment of information risks and investment views.