Diversified Risk Parity Strategies for Equity Portfolio Selection
Posted: 1 May 2012 Last revised: 17 Sep 2012
Date Written: May 9, 2012
We investigate a new way of equity portfolio selection that provides maximum diversification along the uncorrelated risk sources inherent in the S&P 500 constituents. This diversified risk parity strategy is distinct from prevailing risk-based portfolio construction paradigms. Especially, the strategy is characterized by a concentrated allocation that actively adjusts to changes in the underlying risk structure. In addition, x-raying the risk and diversification characteristics of traditional risk-based strategies like 1/N, minimum-variance, risk parity, or the most-diversified portfolio we find the diversified risk parity strategy to be superior. While most of these alternatives crucially pick up risk-based pricing anomalies like the low-volatility anomaly we observe the diversified risk parity strategy to more effectively exploit systematic factor tilts.
Keywords: risk-based portfolio construction, risk parity, diversification, entropy
JEL Classification: G11, D81
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