Financial Risk Management
Risk Parity Approach: Empirical Evidence from US and Indian Equity Index

Article Details
Pub. Date : Mar, 2019
Product Name : The IUP Journal of Financial Risk Management
Product Type : Article
Product Code : IJFRM11903
Author Name : Tirthank Shah and Abhishek Parikh
Availability : YES
Subject/Domain : Finance Management
Download Format : PDF Format
No. of Pages : 09

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Abstract

Risk parity approach being one of the risk-based approaches has emerged, especially after the 2008 crisis, as a promising alternative to asset allocation in order to achieve better risk diversification of the portfolio. Literature review suggests that emerging market indices have remained out of the focus in terms of empirical testing of risk parity portfolio. This paper attempts to bridge the gap by conducting empirical testing of risk parity approach on Indian equity index along with US equity index. The study presents a comparative snapshot of empirical evidence of risk parity portfolio with other risk-based approaches like minimum variance portfolio, equal weight portfolio and most diversified portfolio. The results of empirical testing for Indian market index show superior Sharpe ratio and Treynor ratio for risk parity portfolio vis-à-vis some other approaches, but for US equity market index, minimum variance portfolio and most diversified portfolio show superior Sharpe ratios. In terms of diversification of unsystematic risk of portfolio, risk parity portfolio has generated better diversification vis-à-vis other approaches in both Indian and US equity market. The findings of this paper demonstrate the superiority of risk parity portfolio in terms of unsystematic risk diversification of portfolio in developed as well as emerging equity market.


Description

Portfolio construction has come a long way since the pioneering work done by Markowitz (1952) which resulted in the mean-variance model. The financial crisis of 2008 has turned the attention of both academicians and practitioners towards risk diversification of the portfolio. As an outcome of this, risk-based approaches as alternative asset allocation methods have received some research energy in the last decade. Risk parity approach, which is considered as risk-based approach, focuses on equal risk distribution among all the assets in the portfolio. At the center of risk parity approach is the idea that each asset or asset class should have equal risk contribution to the total risk of the portfolio (Qian, 2005). Risk parity allocates the weights in such a way that it equalizes weighted marginal risk contribution (as defined by Maillard et al., 2010) of every asset in the portfolio.


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