FRM Part II · FRM Exam Part II · Portfolio Construction
A portfolio manager allocates capital across three asset classes so that each contributes exactly one-third of total portfolio volatility. Which description best fits this allocation approach?
This is risk parity: weights are chosen so every asset class contributes the same share of total portfolio volatility. It differs from equal-weighting, which splits capital equally but typically leaves risk contributions unequal when volatilities or correlations differ across the assets.
- AEqual-weighted allocation, where each asset class receives one-third of capital
- BRisk parity, where each asset class contributes equally to total portfolio riskCorrect
- CMinimum-variance allocation, where weights minimize total portfolio volatility regardless of contributions
- DMaximum diversification allocation, where weights maximize expected return per unit of capital
Explanation
Risk parity sets weights so that each asset's risk contribution (weight times marginal contribution to risk) is equal. Equal capital weighting generally produces unequal risk contributions when volatilities differ. Minimum variance does not target equal contributions.
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