Risk parity
Setting weights so that each asset class contributes the same amount to total portfolio risk. Low-volatility assets such as bonds get large weights, and leverage is often needed to reach a useful return.
Where you will meet it
Risk parity appears in 2 learning outcomes on the CFA syllabus. A few of them:
- Analyse active strategies built on factor exposures, including the reasoning behind them and the steps involved
“The process defines each factor, often as a hedged portfolio long the top-ranked and short the bottom-ranked stocks, tests its historical premium, then combines factors, either with fixed weights, by equalising risk contributions (risk parity) or by timing them with valuation or regime signals.”
- Assess heuristic and other rule-based methods of setting an asset allocation
“Risk parity sets weights so each asset class contributes equally to total risk, which usually requires leverage on bonds and ignores expected returns.”
Practise it
Practise risk parity until it is automatic: questions that explain every wrong option.
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