An allocation method that sizes assets so each contributes a similar amount of risk to the portfolio, rather than a similar amount of capital.
In a 60/40 split by capital, equities typically supply more than 90% of the portfolio's risk because they are several times more volatile than bonds. Risk parity reweights so that each sleeve contributes equally, which usually means far more bonds and far less equity by dollar value.
Simple version: if equities run at 16% volatility and bonds at 5%, equal risk contribution needs weights inversely proportional to volatility. Weight to equities is (1/16) / (1/16 + 1/5) = 24%, bonds 76%. Because that portfolio's expected return is low, practitioners often apply leverage to lift it back to a target volatility.
The risks are the ones leverage always brings: financing cost, forced deleveraging, and the assumption that historical correlations hold. A period where bonds and equities fall together hurts a levered risk parity book more than an unlevered 60/40.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
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