The Value-Drivers of Risk Parity and its Component Portfolios
Posted: 23 Sep 2019
Date Written: September 13, 2019
The aim of this paper is to provide more transparency regarding risk parity portfolios. We design a structural framework to properly describe, evaluate, and improve the performance characteristics of risk parity portfolios. This is achieved by segregating the input parameter for the risk parity portfolio, namely the variance covariance matrix, into the volatility vector and correlation matrix, and accordingly, develop a volatility-timing and a correlationtiming portfolio, which maintain the characteristics of risk parity under specific assumptions. We investigate the relationship of the risk parity portfolio with the aforementioned portfolios and show why risk parity as an allocation scheme is methodologically constructed to achieve a superior risk-adjusted performance as compared to that of traditional and heuristic weighting techniques. Finally, we demonstrate how the risk parity portfolio can be improved according to different market situations.
Keywords: Portfolio Optimization, Risk Parity
JEL Classification: C52, C61, G11
Suggested Citation: Suggested Citation