Leverage Aversion and Risk Parity

Abstract

The authors show that leverage aversion changes the predictions of modern portfolio theory: Safer assets must offer higher risk-adjusted returns than riskier assets. Consuming the high risk-adjusted returns of safer assets requires leverage, creating an opportunity for investors with the ability to apply leverage. Risk parity portfolios exploit this opportunity by equalizing the risk allocation across asset classes, thus overweighting safer assets relative to their weight in the market portfolio.

Keywords: Portfolio Management, Portfolio Concepts from Capital Market Theory, Markowitz Portfolio Theory, Risk Management, Risk Management, Portfolio Risk Management, Risk Management Strategies