Low Volatility Needs Little Trading
19 Pages Posted: 1 Jun 2015 Last revised: 26 Apr 2017
Date Written: April 26, 2017
An efficient low-volatility strategy only needs a little amount of trading. The empirical literature on low-volatility investing reveals a concave relation between the amount of trading and the risk reduction. Portfolio simulations confirm this non-linear pattern in which each increase in turnover results in smaller marginal reductions in volatility. In general a moderate trading level of 30% is enough to reduce portfolio volatility by 25% compared with the market index. In addition, low-volatility stocks are relatively liquid and cheap to trade, primarily because they are much larger than the average stock. The law of diminishing returns also applies to other alpha factors such as value and momentum and integrating them into a multi-factor low-volatility strategy is an efficient way to increase factor exposure at low trading costs.
Keywords: low-volatility investing, meta-study, turnover, risk-reduction, overconfidence
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation