Maimonides risk parity

Abstract

Drawing on and extending an estate allocation algorithm of twelfth-century philosopher Moses ben Maimon, we show how ‘Maimonides Risk Parity’ can link together the equal-weighted, market capitalisation-weighted, and risk parity portfolios in a unified, elegant, and concise theoretical framework, with only a single intuitive parameter: the portfolio risk. We also compare the empirical performance of Maimonides risk parity with standard risk parity and equal-weighted portfolios using monthly equity and bond returns for the past six decades and find that Maimonides risk parity outperforms risk parity for any value of the portfolio risk, and outperforms the equal-weighted portfolio for most values of portfolio risk. We also discuss the optimal choice of portfolio risk. The superior performance of Maimonides risk parity comes from the algorithm's natural ability to robustly incorporate measurement error of seemingly small estimated risk.