Diversification Benefits for Risk Parity

34 Pages Posted: 8 Jul 2019 Last revised: 11 Jan 2023

See all articles by Nabil Alkafri

Nabil Alkafri

WHU - Otto Beisheim School of Management

Josephine Molleyres

Swiss National Bank (SNB)

Date Written: July 4, 2019

Abstract

We investigate the out-of-sample diversification benefits of risk parity portfolios by analyzing the properties an asset class has to fulfill in order to be beneficial in a risk parity strategy and compare them with benefits present in other heuristic weighting techniques, especially risk-based strategies. We find that risk parity portfolios achieve a superior risk-adjusted return over multiple financial cycles than most other popular weighting strategies while yielding a lower risk exposure and volatility. However, risk parity is more sensitive to the properties of its constituents than other weighting strategies and adding a negative risk premium asset can substantially deteriorate its risk-return profile.

Keywords: Asset Allocation Models, Diversification, Out-of-Sample Portfolio Optimization, Performance Evaluation, Risk Parity

JEL Classification: C52, C61, G11

Suggested Citation

Alkafri, Nabil and Molleyres, Josephine, Diversification Benefits for Risk Parity (July 4, 2019). Available at SSRN: https://ssrn.com/abstract=3414985 or http://dx.doi.org/10.2139/ssrn.3414985

Nabil Alkafri (Contact Author)

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany

Josephine Molleyres

Swiss National Bank (SNB) ( email )

Bundesplatz 1
Bern, CH-3001
Switzerland
+41764596419 (Phone)

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