Calm ocean with boats symbolizing stable investments amid market volatility.

Beyond Volatility: How Risk Parity Portfolios Using Mean Absolute Deviation Can Smooth Your Investment Journey

Elliot Brynn in Business & Economy December 2025 • 4 min read.

"Discover how incorporating Mean Absolute Deviation (MAD) into risk parity portfolio construction can lead to more balanced and resilient investment strategies."

In today's uncertain financial landscape, investors are constantly seeking strategies to optimize returns while effectively managing risk. Traditional investment models often rely on volatility as the primary measure of risk. However, a growing body of research suggests that volatility alone may not provide a complete picture. This has led to increased interest in alternative risk measures and portfolio construction techniques.

One such technique is the Risk Parity (RP) approach, which aims to allocate assets in a portfolio so that each asset contributes equally to the overall portfolio risk. This strategy contrasts with traditional methods that focus on maximizing returns, often leading to concentrated positions in a few high-performing assets. While RP strategies have gained popularity, their reliance on volatility as the sole risk measure can be limiting. To address this, researchers have explored incorporating other risk measures, such as Mean Absolute Deviation (MAD), into the RP framework.

This article delves into the concept of using MAD in risk parity portfolios. We'll explore what MAD is, how it differs from volatility, and the potential benefits it offers for creating more balanced and robust investment portfolios. Whether you're a seasoned investor or just starting, understanding these concepts can empower you to make more informed decisions about your financial future.

What is Mean Absolute Deviation (MAD) and Why Does It Matter?

Calm ocean with boats symbolizing stable investments amid market volatility.

Mean Absolute Deviation (MAD) is a statistical measure that quantifies the average absolute difference between each data point and the mean of the dataset. In simpler terms, it tells you how spread out the data is around its average value. Unlike volatility, which measures the square of the deviations from the mean, MAD focuses on the absolute values. This makes MAD less sensitive to extreme values or outliers in the data.

So, why is this important for investors? Volatility, while widely used, can be heavily influenced by a few large price swings, potentially overstating the true risk of an asset. MAD, on the other hand, provides a more stable and reliable measure of risk, especially in markets characterized by occasional extreme events. By incorporating MAD into portfolio construction, investors can potentially reduce the impact of outliers and create portfolios that are less reactive to short-term market fluctuations.

Here's a breakdown of the key advantages of using MAD:

Less Sensitive to Outliers: MAD gives a more accurate representation of typical price fluctuations by minimizing the impact of extreme values.
Focus on Downside Risk: By considering absolute deviations, MAD gives equal weight to both positive and negative deviations, providing a balanced view of potential losses.
Improved Portfolio Stability: MAD can lead to portfolios that are less sensitive to short-term market noise, improving overall portfolio stability.

Ultimately, the choice between volatility and MAD depends on the investor's specific goals and risk tolerance. However, by understanding the strengths and weaknesses of each measure, investors can make more informed decisions about how to assess and manage risk in their portfolios. The goal for an investor is not to avoid risk but to manage it intelligently.

Embracing Balanced Risk Management

Incorporating Mean Absolute Deviation (MAD) into risk parity portfolios offers a compelling alternative to relying solely on volatility. By understanding the nuances of MAD and its potential benefits, investors can build portfolios that are more resilient to market fluctuations and better aligned with their individual risk profiles. As the financial landscape continues to evolve, embracing innovative risk management techniques like MAD-based risk parity strategies can pave the way for a smoother and more secure investment journey.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: 10.1007/s10479-023-05797-2,

Title: Mad Risk Parity Portfolios

Subject: q-fin.pm q-fin.rm

Authors: Çağın Ararat, Francesco Cesarone, Mustafa Çelebi Pınar, Jacopo Maria Ricci

Published: 23-10-2021

Everything You Need To Know

What is Mean Absolute Deviation (MAD), and how does it differ from volatility as a measure of risk in investment portfolios?

Mean Absolute Deviation (MAD) is a statistical measure that calculates the average absolute difference between each data point and the mean of the dataset. Unlike volatility, which measures the squared deviations from the mean, MAD uses absolute values, making it less sensitive to extreme values or outliers. Volatility can be heavily influenced by a few large price swings, potentially overstating the true risk of an asset, while MAD provides a more stable and reliable measure, especially in markets prone to occasional extreme events.

How does incorporating Mean Absolute Deviation (MAD) into Risk Parity (RP) portfolios potentially improve portfolio stability and performance?

Incorporating Mean Absolute Deviation (MAD) into Risk Parity (RP) portfolios can lead to more balanced and resilient investment strategies. MAD's reduced sensitivity to outliers and focus on absolute deviations can mitigate the impact of short-term market fluctuations. This approach contrasts with traditional RP strategies relying solely on volatility, which may lead to over-concentration in certain assets and increased portfolio instability during volatile periods. By diversifying risk contributions using MAD, portfolios can achieve smoother performance and better alignment with individual risk profiles.

What are the key advantages of using Mean Absolute Deviation (MAD) in investment portfolio construction, compared to using volatility alone?

The key advantages of using Mean Absolute Deviation (MAD) include: Reduced sensitivity to outliers, providing a more accurate representation of typical price fluctuations; A balanced view of potential losses, as MAD gives equal weight to both positive and negative deviations; Improved portfolio stability, making portfolios less sensitive to short-term market noise. While volatility is influenced by extreme values, MAD offers a more stable measure, especially beneficial in markets with frequent extreme events, leading to more robust investment decisions.

In what scenarios might using Mean Absolute Deviation (MAD) be more appropriate than using volatility when constructing a Risk Parity portfolio?

Using Mean Absolute Deviation (MAD) might be more appropriate than using volatility in scenarios where markets are characterized by occasional extreme events or outliers. MAD's focus on absolute deviations and reduced sensitivity to extreme values provide a more reliable measure of risk, particularly when large price swings can distort volatility metrics. Additionally, MAD's balanced view of potential gains and losses aligns well with risk parity's goal of equal risk contribution from each asset, especially when investors are concerned about downside risk and prefer a more stable portfolio.

How can investors practically implement Mean Absolute Deviation (MAD) into their risk management strategies, and what considerations should they keep in mind?

Investors can implement Mean Absolute Deviation (MAD) by calculating the average absolute difference between each data point and the mean of the dataset for various assets. This involves gathering historical price data, computing the mean for each asset, calculating the absolute deviations from the mean, and averaging these deviations to obtain the MAD. When incorporating MAD into risk parity portfolios, investors should consider their risk tolerance, investment goals, and the specific characteristics of the assets included. It's also crucial to regularly monitor and adjust the portfolio based on changing market conditions and asset performance to ensure alignment with the investor's overall financial objectives. Understanding the strengths and limitations of both MAD and volatility is essential for making informed decisions.