Performance of Risk Parity Strategy in Developed Markets

Abstract

This study examines the performance and effectiveness of the Risk Parity (RP) strategy in strategic asset allocation specifically utilizing the inverse volatility (IV) approach. The study utilizes data from 13 developed countries, encompassing stocks and government data, to analyze the performance of RP portfolio. A comparative analysis is conducted between the RP portfolio, traditional 60/40 and equal-weighted portfolios across significant market crises, including the dot-com crisis, financial crisis, sovereign debt crisis, and COVID-19 pandemic. This study reveals that inverse volatility approach or a portfolio with a higher weight towards safer assets compared to riskier assets delivers superior risk-adjusted returns. It presents evidence that challenges the notion of the market or 60/40 portfolio as an efficient portfolio and suggests that an alternative portfolio such as RP may offer superior efficiency in terms of risk and return. Moreover, the study examines the role of leveraging in RP portfolios, highlighting how investors can align risk levels with benchmark portfolios while achieving higher risk-adjusted returns. The findings highlight the substantial impact of leveraging on RP portfolio performance, demonstrating their resilience and superiority even in challenging market conditions.