An Equal Risk Contribution Portfolio Approach Using VIX Futures

Abstract: As an effect of the unusually volatile financial markets the past few years, new asset allocation strategies such as the equal risk contribution (ERC) approach has been developed. This report examines the effect on portfolio performance of adding VIX Futures contracts to an ERC portfolio consisting of positions in long-term government bonds and S\&P 500 equities. The investigation is conducted through simulations using a model based on data from 2004-2008, and is supplemented by a study of the tail event in 2008-2009. The results suggest that the inclusion of VIX Futures positions substantially improves portfolio performance in terms of Sharpe ratio, and is also shown to remain significant when adjusting for transaction costs and diversification effects. Thus, investors and asset managers using the ERC approach could benefit from adding VIX Futures positions to their portfolios.