Risk Parity

Risk parity is a portfolio construction method that allocates capital so that each asset or component contributes equally to overall portfolio risk, rather than allocating based on expected returns. Traditional portfolios often concentrate risk in equities because they are more volatile than bonds or cash. Risk parity adjusts position sizes so lower-volatility assets receive higher weights, balancing risk contributions across holdings. In quantitative strategies, risk parity is implemented by scaling allocations inversely to volatility or using covariance matrices to equalize risk contributions. The result is a portfolio designed for smoother performance across market cycles. Risk parity emphasizes diversification at the risk level, not just at the asset level. This approach can reduce drawdowns and improve consistency, especially during equity market stress. However, risk parity does not guarantee higher returns. It is primarily a risk management framework. Performance depends on how underlying assets behave and whether leverage is used. In equity-focused quant models, risk parity concepts are often applied within stock portfolios to balance sector or factor risk rather than across asset classes. At its core, risk parity shifts thinking from “how much capital” to “how much risk.”