Does Risk Parity Maximize Risk-adjusted Returns?
This white paper looks at the period of the increased volatility in the financial markets leading up to and on November 8th and provides valuable insights into internal workings of risk parity strategies during periods of heightened volatility.
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.
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