Robustness of Stable Volatility Strategies

53 Pages Posted: 4 Dec 2014 Last revised: 13 May 2015

See all articles by Nicole Branger

Nicole Branger

University of Muenster - Finance Center Muenster

Antje Brigitte Mahayni

Mercator School of Management

Daniel Zieling

University of Duisburg-Essen - Mercator School of Management

Date Written: April 29, 2015

Abstract

The paper analyzes the robustness of stable volatility strategies, i.e. strategies in which the portfolio weight of the stock is inversely proportional to its local volatility. These strategies are optimal for a CRRA investor if the stock follows a diffusion process, the expected excess return is proportional to its volatility, and the hedging demand is zero. We assess the performance of stable volatility strategies when these restrictive assumptions do not hold, in particular, when the risk premium is not proportional to volatility and when the stock price is subject to jumps. We find that stable volatility strategies are indeed robust or close to robust under a maxmin decision rule. In addition to our theoretical results, we perform a simulation analysis to evaluate strategies that scale the portfolio weight by the volatility, variance or a constant portfolio weight, and also analyze the strategies using empirical excess returns. Both analyses confirm the robustness of stable volatility strategies.

Keywords: Stable volatility strategies, jump diffusion processes, model risk, robustness, performance evaluation

JEL Classification: G11, G12

Suggested Citation

Branger, Nicole and Mahayni, Antje B. and Zieling, Daniel, Robustness of Stable Volatility Strategies (April 29, 2015). Available at SSRN: https://ssrn.com/abstract=2533389 or http://dx.doi.org/10.2139/ssrn.2533389

Nicole Branger (Contact Author)

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

Antje B. Mahayni

Mercator School of Management ( email )

Lotharstraße 65
Duisburg, Nordrhein-Westfalen 47057
Germany

Daniel Zieling

University of Duisburg-Essen - Mercator School of Management ( email )

Lotharstraße 65
Duisburg, Nordrhein-Westfalen 47057
Germany

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