Exploring Risk-Based Portfolio Construction: Empirical Evaluation of Equal Risk Contribution and Inverse Volatility Portfolios

Abstract

We examine the effectiveness of risk-based portfolio construction methods, specifically Equal Risk Contribution (ERC) and Inverse Volatility (IVP), using the same data set and performance measures as in DeMiguel, Garlappi, and Uppal’s study from 2009 on the mean-variance model and its extensions. We create portfolios and evaluate their out-of-sample performance against the Equal Weighted (EW) strategy in terms of Sharpe Ratio, Certainty Equivalent, and turnover. Findings suggest that while ERC and IVP do not consistently outperform the EW strategy, they demonstrate significant potential, often matching or surpassing EW’s performance.