How bond risk affects risk parity portfolios

Abstract

We document the performance of risk parity portfolios (RPP) of U.S. equities and government bonds over more than fty years of daily and monthly data. RPP's strong outperformance compared to 60/40 portfolios has to some extent relied on sub-periods of falling interests rates. RPP have a large tail risk materializing in periods of sharply rising interest rates together with recession or stag ation. In these situations, positive return correlation together with rising rates have a very negative impact on both RPP and 60/40 portfolios, with RPP su ering the larger tail loss. We also analyze how volatility variation of equities and bonds a ect RPP's volatility theoretically and empirically. Keywords: Risk parity portfolio, Government bond, Government bond yield, volatility variation