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A Modified Risk Parity Method for Asset Allocation

Author

Listed:
  • Akhilesh Maewal
  • Joel R. Bock

    (Yale University
    University of California, San Diego)

Abstract

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.

Suggested Citation

  • Akhilesh Maewal & Joel R. Bock, 2019. "A Modified Risk Parity Method for Asset Allocation," Journal of Economics and Financial Analysis, Tripal Publishing House, vol. 3(1), pages 71-85.
    • Handle: RePEc:trp:01jefa:jefa0028
    DOI: 10.1991/jefa.v3i1.a24
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    References listed on IDEAS

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    1. repec:dau:papers:123456789/4688 is not listed on IDEAS
    2. Richard H. Thaler & Shlomo Benartzi, 2001. "Naive Diversification Strategies in Defined Contribution Saving Plans," American Economic Review, American Economic Association, vol. 91(1), pages 79-98, March.
    3. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
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    More about this item

    Keywords

    Risk Parity; Asset Allocotion; Decision Making; Portfolio Optimizaion.;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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