A Modified Risk Parity Method for Asset Allocation
16 Pages Posted: 15 Nov 2018
Date Written: October 23, 2018
We propose a return based modiﬁcation of the portfolio variance matrix for asset allocation using risk parity. The modiﬁcation is based upon a single scalar parameter which can be tuned to tailor the allocation for desired expected risk and/or return. The present work contributes a new twist on risk parity. While classical risk parity methods are based exclusively on volatility, the new solution (Modiﬁed Risk Parity) considers both historical returns and their variance in the construction of an optimal, diversiﬁed investment portfolio. We present two examples for periods including the recent ﬁnancial market crises. The results suggest that the modiﬁcation may lead to signiﬁcantly improved risk adjusted returns over those realized by the conventional risk parity method.
Keywords: Risk Parity, Asset Allocation, Minimum Variance, Optimal Portfolio
JEL Classification: G11
Suggested Citation: Suggested Citation