Risk parity

Setting weights so that each asset class contributes the same amount to total portfolio risk. Low-volatility assets such as bonds get large weights, and leverage is often needed to reach a useful return.

Where you will meet it

Risk parity appears in 2 learning outcomes on the CFA syllabus. A few of them:

• Analyse active strategies built on factor exposures, including the reasoning behind them and the steps involved
  CFA Level III · Portfolio Management Pathway

  “The process defines each factor, often as a hedged portfolio long the top-ranked and short the bottom-ranked stocks, tests its historical premium, then combines factors, either with fixed weights, by equalising risk contributions (risk parity) or by timing them with valuation or regime signals.”

• Assess heuristic and other rule-based methods of setting an asset allocation
  CFA Level III · Asset Allocation

  “Risk parity sets weights so each asset class contributes equally to total risk, which usually requires leverage on bonds and ignores expected returns.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with R · Glossary