Uncertain Risk Parity
8 Pages Posted: 24 Jun 2019 Last revised: 25 Sep 2019
Date Written: June 18, 2019
Risk parity is portfolio construction technique that, using risk alone, scales each part of a portfolio — e.g., stocks, bonds, currencies, commodities — so that its contribution to net portfolio risk matches its budgeted risk. Because risks are measured using a point-estimate of covariance, the method is subject to problems arising from estimation error. This paper performs risk parity with covariance modeled as uncertain in order to achieve a weighting robust to changes in regime and hidden risks arising from misperceived hedging.
Keywords: Covariance, Estimation Error, Factor Models, Portfolio Construction, Regularization, Risk Parity, Uncertainty
JEL Classification: G11, C6
Suggested Citation: Suggested Citation