The Comparison Study Between Risk Parity And Other Asset Allocation Methods

There is nothing new under the sun, so is the capital market. The market has its own logic, such as industry sector rotation, the good performance of Small cap stocks and the low risk of government bonds. It is important for every investor to appropriately allocate her money into different asset classes. Under well-known assumptions about the distribution of the yield of assets, Two-Fund Theorem tells that one typical investor will hold the small risky portfolio regardless of her individual preference. In other words, the constituents in the optimal risky portfolio are the same for all the investors. However, the kind of asset allocation based on mean-variance framework is often regarded as a passive one. In the same time, the kind of asset allocation show its drawbacks when the market suffers from drawdowns (2008 Financial Crisis).This paper sheds light on one recently acclaimed kind of asset allocation methods—Risk Parity, examines its theoretical foundation, and runs a Horse Race between RP portfolio and others portfolios, such as the efficient portfolio based on mean-variance analysis, equal-weighted portfolio, minimum variance portfolio and the portfolio based on momentum strategy. And all the portfolios are constructed employing the Chinese market data.Finally, we find that during the Holding period, the RP portfolio can consistently deliver a good performance in terms of Sharpe Ratio, and RP portfolio also has relatively high average return. Meanwhile, RP portfolio has less risk concentration in certain asset classes compared with the minimum risk portfolio, and its cost of trading is lower. So Risk Parity seems like a promising method of asset allocation in Chinese market.