Balancing Asset Growth and Liability Hedging through
Risk Parity

Abstract

In this article, the author shows that risk parity strategies offer liability-hedging benefits in addition to exposure to growth assets. Risk parity portfolios are typically levered so that risks can be balanced across asset classes. The effect of doing so effectively levers low-risk assets like bonds and de-levers high-risk assets like stocks. The effective leverage of the bond component increases its duration, giving many risk parity portfolios durations similar to those of defined-benefit plans. This is not liability-directed investment, which targets a particular liability, but it does give liability-hedging properties, which other investment strategies typically do not offer. In addition, this study shows that periods of high and low volatility can affect the ability of a static mix of assets to effectively hedge liabilities.

TOPICS: Risk management, volatility measures