Downside Risk-Parity Portfolio

Abstract

The authors propose in this article a downside risk-parity strategy for optimal asset allocation. In contrast to the classical risk-parity strategy, this new strategy requires that each asset in a portfolio contribute the same downside risk to the portfolio’s total downside risk. By focusing on the downside semivariance rather than the whole variance, the proposed strategy has the potential to eschew huge loss and, hence, to realize stable performance and a high Sharpe ratio in the long run. The authors demonstrate the satisfactory properties of the proposed strategy via extensive empirical analyses. The proposed downside risk-parity strategy outperforms risk parity, minimum variance, and other risk-based strategies, with a higher Sharpe ratio and smaller maximum drawdown in most cases.