Risk Parity

Risk parity allocates capital so each asset class contributes equally to portfolio risk, not equally by dollar amount. Traditional 60/40 (stocks/bonds) is dominated by equity risk (stocks are 3x more volatile). Risk parity might be 30% stocks / 70% bonds, using leverage on bonds to equalize risk contributions. Calculation: Allocate weights such that w_i × σ_i × ρ_i,p = constant for all assets. Example: If stocks have 15% vol and bonds have 5% vol, you'd hold 3x more bonds by weight to equalize risk. Benefit: Better diversification — no single asset dominates risk. Popularized by: Bridgewater's All Weather Fund. Criticism: Requires leverage, performs poorly when all assets decline together (2022: stocks and bonds both down).