Definition
Risk Parity
Risk parity is a portfolio construction approach that allocates capital so that each asset or asset class contributes equally to total portfolio risk, rather than weighting by capital invested.
Instead of a conventional 60/40 split where equities dominate the risk, an Indian risk-parity portfolio might hold more bonds and use leverage so that equities, bonds and other assets each add a similar share of volatility. The aim is steadier returns across economic regimes.
Risk parity depends heavily on accurate volatility and correlation estimates and often on leverage, which introduces funding and liquidity risk, exposed during shocks when correlations spike. In India, implementation is constrained by limited cheap leverage and a narrower set of liquid, low-correlation assets than in developed markets.
Related terms
- Low-Volatility FactorThe low-volatility factor exploits the anomaly that stocks with lower historical price volatility have tended to deliver better risk-adjusted, and sometimes higher absolute, returns than high-volatility stocks.
- Sharpe Ratio OptimisationSharpe ratio optimisation is the process of constructing or tuning a portfolio or strategy to maximise return per unit of risk, measured as excess return divided by volatility.
- Kelly CriterionThe Kelly criterion is a position-sizing formula that determines the fraction of capital to risk on a bet or trade to maximise the long-run growth rate of wealth, given the edge and odds.
- Monte Carlo SimulationMonte Carlo simulation is a technique that runs thousands of randomised scenarios to model the range of possible outcomes for a strategy or portfolio, revealing the distribution of returns, drawdowns and risk.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.