Volatility-Managed Portfolios: True Market-Timing with a False Theory?

Abstract

The volatility-managed portfolio (VMP) offers an appealing market-timing strategy (Moreira and Muir, Journal of Finance, 2017). Unfortunately, an important theoretical result for VMP and the foundation of the paper’s empirical study, namely the arbitrariness of the constant c in the portfolio weight factor, seem questionable. We prove that the VMP alpha from a slightly modified theory isn’t guaranteed to be positive under any circumstance, casting doubt on the Moreira-Muir results. In a case with inferable positive Moreira-Muir alphas, our simulations show that statistically significant alphas are rare and volatility-managed portfolios frequently lose all investments, contradicting the Moreira-Muir theory.

Keywords: volatility-managed portfolio; market-timing strategy; Moreira-Muir alpha; compounding-based VMP theory

JEL Classification: G11, G10