An asset class groups investments with broadly similar financial characteristics and market behavior. Portfolio construction can treat asset classes as higher-level buckets represented by tradable instruments. section 11.2.3
A portfolio may divide equities, bonds, and commodities into geographic or market-cap segments, with ETFs representing the most granular constituents. Equal risk across instruments can still overweight larger buckets by instrument count. section 11.2.3
Weighted risk parity addresses that concentration by assigning each instrument a target contribution within its asset class:
- Four equity instruments, three bond instruments, and one commodity instrument can produce 50%, 3/8, and 1/8 of portfolio risk under unweighted parity. section 11.2.3
- Weighting instruments inversely by the number in each bucket targets equal risk from each top-level asset class and equal risk within each class. section 11.2.3
Eight-instrument allocation
Use VV, VB, VEA, VWO, AGG, BNDX, EMB, and DJP as equity, bond, and commodity representatives; estimate covariance and solve the weighted risk-parity objective.
