Risk Parity Equity Strategy with Flexible Risk Targets

Abstract

Risk-based investment strategies such as Risk Parity and minimum variance tend to have better long term risk-adjusted returns but lower risks than traditional capital-based investment strategies. In order to either derive higher return or to better manage risk, it is often desirable to design risk-based strategies with higher risk targets. We discuss the ways to do so for Risk Parity equity portfolios. The targeted portfolio is long-only with a “130/0”-like structure. We show that a synthetic portfolio with stocks and equity index futures can closely mimic the target portfolio with minimal tracking error and similar Sharpe ratio.

TOPICS: VAR and use of alternative risk measures of trading risk, equity portfolio management