Agnostic Risk Parity for Diversifying Portfolio Bets

Summary

This note introduces Eigenrisk Parity, a portfolio construction approach that allocates risk evenly across the principal components of a covariance matrix. The broader idea is to use symmetry rather than rely on precise forecasts of returns and correlations. The framework can also be expressed using other definitions of uncorrelated factors, extending the principle beyond principal components.

Agnostic Risk Parity is a special case that assumes future-return indicators are uncorrelated and have equal variance. Under that assumption, it seeks to limit unknown-unknown risks that can arise when a portfolio relies too heavily on optimistic hedging between bets. The note reports that the method performs reasonably well when applied to standard technical strategies such as trend following. The supplied description does not provide implementation details, comparison metrics, or the underlying test design, so it does not establish how the approach behaves across other portfolios or market conditions.

Key ideas

• Eigenrisk Parity aims to equalize realized risk across covariance-matrix principal components.
• The general framework relies on symmetry arguments and can use alternative definitions of uncorrelated factors.
• Agnostic Risk Parity assumes future-return indicators are uncorrelated and equally variable.
• The method is intended to reduce risks from overly optimistic hedging among portfolio bets.
• The note reports reasonable results on trend-following strategies but gives limited detail on the evaluation.

Tags

# Agnostic Risk Parity: Taming Known and Unknown-Unknowns


# Agnostic Risk Parity: Taming Known and Unknown-Unknowns









Markowitz' celebrated optimal portfolio theory generally fails to deliver out-of-sample diversification. In this note, we propose a new portfolio construction strategy based on symmetry arguments only, leading to "Eigenrisk Parity" portfolios that achieve equal realized risk on all the principal components of the covariance matrix. This holds true for any other definition of uncorrelated factors. We then specialize our general formula to the most agnostic case where the indicators of future returns are assumed to be uncorrelated and of equal variance. This "Agnostic Risk Parity" (AGP) portfolio minimizes unknown-unknown risks generated by over-optimistic hedging of the different bets. AGP is shown to fare quite well when applied to standard technical strategies such as trend following.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.