FRM Part II · FRM Exam Part II · Portfolio Construction
A two-asset portfolio has zero correlation between assets. Asset A has volatility 10% and Asset B has volatility 20%. Using a naive risk parity (inverse-volatility) approach, what are the weights of A and B?
Inverse-volatility weights are proportional to 1/10 and 1/20, giving 67% to Asset A and 33% to Asset B. With zero correlation this makes each asset's risk contribution equal, since weight times volatility is the same for both assets.
- A50% and 50%
- B80% and 20%
- C67% and 33%Correct
- D33% and 67%
Explanation
Inverse volatilities are 1/10 = 0.10 and 1/20 = 0.05, summing to 0.15. Weights are 0.10/0.15 = 66.7% for A and 0.05/0.15 = 33.3% for B. Check: risk contributions with zero correlation are w²σ²: (0.667×10)² = 44.4 and (0.333×20)² = 44.4, equal. The 33/67 option inverts the weights.
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