Risk Parity Optimality

Abstract

In this article, the authors show under general conditions that the probability of risk parity beating any other portfolio is more than 50%. They also prove the maximin properties of a risk-parity portfolio under two scenarios: 1) when all assets’ future Sharpe ratios are greater than some positive unknown constant and all correlations are less than another unknown constant, or 2) when the sum of all assets’ future Sharpe ratios is greater than some unknown constant. In each case, the authors show that risk parity is the unique maximin portfolio. Finally, the authors empirically confirm their theoretical results for the two main asset classes.

TOPICS: Portfolio construction, analysis of individual factors/risk premia, statistical methods