A portfolio construction strategy and methodology that involves equating the contribution to risk from every group of assets (portfolio) taking into consideration the correlation between each pair of assets. This is a long term allocation that is designed to allocate risk equally so that each component or constituent contributes equally to the portfolio’s overall volatility. In other words, each constituent has its own marginal risk contribution. Thus the risk of the portfolio can be perceived as, or determined to be, the sum of the total risk contributions, resulting in a truly diversified portfolio in terms of the overall risk.
Risk parity (equal risk contribution, or ERC) implies equal weights assigned to constituents, where the standard deviation risk contribution of a component asset is the weighted average of its return contribution and its risk contribution.
It is also known as equal risk contribution scheme.
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