Rebalancing and risk tolerance

Just in case we face any tricky question on this: 1. Constant mix: a. positive absolute risk tolerance (related to wealth) b. constant relative risk tolerance (more equities, ok, but in same ratio) 2. Buy and hold: a. positive absolute risk tolerance (related to wealth) b. positive relative risk tolerance (more equities, and perhaps even more and more, ratio can change) 3. CPPI: a. positive absolute risk tolerance (related to wealth) b. positive relative risk tolerance (more and more equities as they go up) do you think this is correct? thanks a lot

What is an absolute risk tolerance? Never saw this concept before. Your tolerance either increases or decreases or stays the same with wealth. It can increase lineary - as in buy and hold, or exponentially as in CPPI

I got it from the cfa text and schweser errata. They sort of mean that you have: - absolute risk tolerance = “you have more USD in equities as they go up (and wealth goes up)” - relative risk tolerance = “yes, but the ratio compared to cash is always the same”

in relative, “is always the same” in the constant mix in buy and hold or cppi, the ratio will change “passively” in buy and hold, and “actively” in cppi

ok i see it now. thanks

my 0.02$ In constant mix, absolute risk tolerance increases “proportionately” with wealth, whereas in buy and hold and CPPI, absolute risk tolerance increases “more than proportionately” with wealth. Buy and hold - passively, CPPI - actively. Reference: Page 372 CFAI text, Example 9. Correct me if im wrong.


also CPPI is convex and constant mix is a concave strategy, holding is linear (in terms of equity composition)

as for me I didn’t get it. could you please explain what does it mean: “with constant-mix strategy, the amount of money invested in risky assets increases with increasing wealth, implying increasing risk tolerance” (p.370) I always thought that risk tolerance is constant for constant-mix strategy regardless of wealth level. If equity is up we’ll sell excess equity and buy bills. where is here the increased risk tolerance ?

you have 100 usd mio in stocks, and 100 usd mio in t-bills (50/50) stocks double you have 200 usd mio in stocks, and 100 usd mio in t-bills (66/33) you rebalance again to get to 50/50 you have 150 usd mio in stocks, and 150 usd mio in t-bills (50/50) as your wealth increased, the amount of usd you have in usd has also increased = increasing risk tolerance in absolute terms, related to wealth even though, the ratio of stocks to t-bills is still the same (50/50) = constant relative risk tolerance hope it helps

yes, thank you very much, Hala now it’s absolutely clear. though it’s still looks rather strange for me to measure risk tolerance in absolute units…seems it’s just one of the possible cfa tricks for June exam

I don´t remember if cfa or schweser (or both) issued some errata on this. I don´t know if this is just tricky or they saw that they f* up with their initial wording anyway, now that we got it, I would love to see a question on this in the exam :slight_smile:

Constant: has a constant risk tolerance regardless of wealth. Buy/Hold: Positive risk tolerance above floor, but drops to zero at the floor. CPPI: INCREASING risk tolerance as wealth increases above floor, drops to zero at floor.

as I far as I remember there is no cfa errata on this. And also in the last year Schweser they didn’t refer to any absolute risk tolerance…just constant risk tolerance for constant mix strategy…so it’s smth new…