Risk Parity, Maximum Diversification,and Minimum Variance: An Analytic Perspective

Analytic solutions to risk parity, maximum diversification, and minimum variance portfolios provide useful perspectives about their construction and composition. Individual asset weights depend on both systematic and idiosyncratic risk in all three risk-based portfolios, but systematic risk eliminat...

Full description

Saved in:
Bibliographic Details
Published inJournal of portfolio management Vol. 39; no. 3; pp. 39 - 53
Main Authors Clarke, Roger, Silva, Harindra de, Thorley, Steven
Format Journal Article
LanguageEnglish
Published London Pageant Media 01.04.2013
Subjects
Asset allocation
Diversification
Parity
Portfolio diversification
Risk factors
Risk management
Standard deviation
Studies
Volatility
Online AccessGet full text

Cover

More Information
Summary:Analytic solutions to risk parity, maximum diversification, and minimum variance portfolios provide useful perspectives about their construction and composition. Individual asset weights depend on both systematic and idiosyncratic risk in all three risk-based portfolios, but systematic risk eliminates many investable assets in long-only, constrained, maximum-diversification, and minimum-variance portfolios. On the other hand, risk-parity portfolios include all investable assets, and idiosyncratic risk has little effect on weight magnitude. The algebraic forms for optimal asset weights derived in this article yield generalizable properties of risk-based portfolios, in contrast to empirical simulations that employ a specific set of historical returns, proprietary risk models, and multiple constraints. These analytic solutions reveal precisely how various kinds of predicted risk affect the relative magnitude of security weights in each type of risk-based portfolio construction. [PUBLICATION ABSTRACT]
ISSN:0095-4918
2168-8656
DOI:10.3905/jpm.2013.39.3.039