Extending the Risk Parity Approach to Higher Moments : Is There Any Value-Added?

The popular risk parity approach is based on volatility as the sole risk measure and therefore lacks the consideration of tail risk. This fact makes risk parity portfolios vulnerable to tail events. In this article the authors address this issue by showing how higher risk moment terms can be consistently incorporated in the risk parity optimization. In addition, they present a novel optimization approach, whereby optimal moment weightings (preferences) in the risk parity optimization are imputed from the data. In a broad-based empirical out-of-sample study and simulation analysis, the authors find superior performance of higher moment risk parity portfolios when the underlying data exhibit significant higher moments and comoments. This fact, according to the authors, renders higher moment risk parity portfolios ideal candidates for worst case regimes