Risk parity is a portfolio management strategy that uses the concept of allocating risk or capital based on ensuring stability across diverse market conditions, balancing various components of an investment portfolio, and the risk contribution of each asset, rather than on expected returns.

It focuses on the amount of risk in a portfolio, rather than the specific monetary amount, as in the case of traditional portfolio management. Proponents of the approach state that risk parity outperforms the traditional approach during bear markets and economic downturns.

This can be done using historical price data, volatility measures and correlations between assets.

The concept attempts to distribute risk equally across an investment portfolio to earn the same return and volatility, or a better return with an equal amount of risk and volatility.

What does Risk Parity seek to achieve?

Diversification: This aims to create a highly diversified portfolio by equalizing the risk exposure of various assets. This strategy can help mitigate the effects of market volatility and enhance the overall stability of the portfolio.

Portfolio Management: The objective of risk parity is to generate returns while limiting risks, resulting in a more effective portfolio. By equalizing risk exposures, investors may be able to attain higher returns adjusted for risk.

Risk-based Allocation: In contrast to traditional portfolio allocation methods that prioritize expected returns or asset categories, risk parity focuses on capital distribution based on the risk profiles of each asset.