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What is tail risk parity?

Tail risk parity

It’s an extension of the risk parity approach, which is when an investment portfolio diversifies assets according to risk. The difference is that it uses tail risk, not volatility, as its core concept. Tail risk parity hedges the risk of large losses, taking into account the behaviour of the portfolio's assets during extreme events.

Where have you heard about tail risk parity?

For any investor, the risk of unexpected heavy losses is a key concern. The goal of the tail risk parity approach is to protect investments during times of economic crisis and reduce the cost of such protection during normal market conditions.

What you need to know about tail risk parity.

The typical portfolio split of investing 60% in stocks and 40% in bonds works well enough when the markets are performing well, but offer little protection in times of crisis. They tend to produce more extreme outcomes on the downside than they do on the upside.

The notion of tail risk parity assigns each asset class to one of three risk buckets – growth, safety and inflation. It then assigns the expected tail loss to each and forms parity across the buckets, with each contributing a third of the tail risk of the portfolio.

Find out more about tail risk parity.

For background information, read our definitions of tail risk and risk parity.

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