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Risk parity strategies with risk factors

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Listed:
  • Yu-Jiu Chen
  • Chen-Yen Hsieh
  • Huei-Wen Teng
  • Ming-Che Hu
  • Alex YiHou Huang

Abstract

This paper evaluates the method of naive risk parity (RP) in portfolio trading, particularly with Standard & Poor’s 500 stocks as components. Several sample selection criteria based on prevalent risk factors are applied, and the dynamic technique of RP is examined. Three performance risk-adjusted ratios and four downside risk measurements are used for evaluation. It is found that both conventional and dynamic versions of RP portfolios generally outperform traditional value-weighted and equal-weighted portfolios. In particular, when firm size is used as a sample selection criterion, RP portfolios show the largest improvements compared with other portfolio types. Various combinations of formation and holding periods are investigated, and the empirical results for subperiods are produced and discussed. When the economy is in a downturn, RP portfolios with a selection criterion based on stock momentum outperform other strategies, presumably due to volatilities among the stocks being highly correlated. This paper sheds light on the application of the RP strategy with components only from stocks, and it shows that for investments with a long horizon, RP constitutes an effective and profitable alternative risk-adjusted strategy.

Suggested Citation

  • Yu-Jiu Chen & Chen-Yen Hsieh & Huei-Wen Teng & Ming-Che Hu & Alex YiHou Huang, . "Risk parity strategies with risk factors," Journal of Risk, Journal of Risk.
    • Handle: RePEc:rsk:journ4:7961863
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