Enhancing Risk Parity by Including Views

Abstract

Within the finance literature, there is an apparent gap between the inherent ignorance of expected returns of a risk parity approach on the one hand, and the assumed certainty of expected returns in a mean–variance approach on the other. The authors propose a portfolio selection framework that allows an investor to position herself between these two extremes. Depending on the confidence in one’s expected return estimates, the optimal portfolio will be tilted more toward the risk parity portfolio or the mean–variance portfolio. The authors illustrate the framework for an investor in an asset allocation context.