Does Risk Parity Maximize Risk-adjusted Returns?

While it is well known that risk parity strategies typically allocate more weight or apply leverage to asset classes with lower risk, it is not well understood how higher volatility affects the Sharpe ratios exhibited by the assets that get over- or under- weighted.  We find that in practice the strategy increases an asset’s weight in periods of lower risk, which ultimately produces higher risk-adjusted returns. As a case in point, investors have been nervous about the US election for a while now, as evident by the increased volatility in the financial markets leading up to and on Nov 8. This recent event prompted us to provide additional comment on how risk parity works in periods of heightened volatility.  Click here to download the PDF.

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