Risk parity is an allocation method that sizes every instrument so that each one contributes the same share of the portfolio's total risk. Equal risk contribution is not the same thing as equal weight: risk parity shrinks the risky positions and enlarges the calm ones until each supplies an equal slice.
Also seen as: equal risk contribution, ERC, risk budgeting
What does "equal risk contribution" mean?
An instrument's risk contribution is its weight multiplied by how much the portfolio's overall volatility changes when that weight changes; the slices add back up to the whole. Risk parity is the weighting that makes every slice equal. If two instruments are held in equal amounts but one is three times as volatile as the other, the volatile one supplies almost all of the portfolio's risk.
- instrument i's risk contribution
- instrument i's weight
- instrument i's marginal effect on the portfolio's volatility
- the portfolio's volatility
Because that marginal effect depends on how the instrument moves against the rest of the portfolio, not only on its own volatility, correlations feed into a risk-parity weighting even though correlation is never something you set.
How does Fincanva handle it?
- Risk parity is included from the Advanced plan, at the strategy level and inside a Combined alike. Free and Starter do not offer it in either place. See what each plan includes.
- It works at both levels: inside a strategy it sizes the instruments the strategy holds; inside a Combined it splits capital across the strategies so each contributes an equal share of the Combined's risk.
- Weights are recomputed at every rebalance from the risk figures measured over the window ending at that date, so a risk-parity weighting drifts over the life of a backtest rather than staying fixed.
- Risk parity never assigns a zero weight to an instrument you have selected: every instrument must carry a slice of the risk, so every instrument gets some weight.
Which settings does Risk parity have?
One: Covariance matrix, which decides how the volatilities and correlations behind the risk contributions are estimated — the plain sample estimate or a corrected one; see covariance matrix. Equalising risk contribution itself leaves nothing to choose. A newly chosen Risk parity starts on Ledoit-Wolf · constant correlation, marked Recommended; a strategy saved before that choice existed keeps the sample estimate, so its results do not change by themselves.
The other input Risk parity reads is the calculation window — the field labelled In-sample in the strategy editor — which sets how many months of history those estimates cover. It defaults to 12 months and accepts any whole number of months from 1 upward. Why the statistic a method treats as "risk" changes its answer at all is covered in risk measure selection.
What does it look like in practice?
A strategy holds two instruments with no tendency to move together. Instrument A has 10% volatility, instrument B has 30%.
- At equal weights (50% / 50%) the risk slices are proportional to (weight × volatility)², so A supplies 0.05² = 0.0025 and B supplies 0.15² = 0.0225 — a split of 10% / 90%. A "balanced" 50-50 portfolio is in fact nine-tenths driven by one instrument.
- Risk parity instead sets the weights to 75% / 25%, because 0.75 × 10% = 0.25 × 30% = 7.5%. Now each instrument supplies exactly half the risk.
The 50-50 portfolio looks balanced by weight and is heavily lopsided by risk; the 75-25 portfolio looks lopsided by weight and is balanced by risk. Which of those two is "balanced" is exactly the question Risk parity answers differently from Equal weights.
How is Risk parity different from Inverse volatility?
Inverse volatility reads each instrument's risk in isolation and weights by one divided by that figure. Risk parity targets the finished portfolio's risk split, which also depends on how the instruments move together. In the two-instrument example on this page the methods happen to agree on 75-25, because the instruments were uncorrelated — that equivalence is a special case, and it breaks as soon as the instruments move together.
Fincanva describes how these methods work; it does not recommend one. See Is this financial advice?.