Volatility Managed Portfolios
University of California, Los Angeles (UCLA) - Anderson School of Management
October 25, 2016
Journal of Finance, Forthcoming
Managed portfolios that take less risk when volatility is high produce large alphas, substantially increase factor Sharpe ratios, and produce large utility gains for mean-variance investors. We document this for the market, value, momentum, profitability, return on equity, and investment factors in equities, as well as the currency carry trade. Volatility timing increases Sharpe ratios because changes in factors' volatilities are not fully offset by proportional changes in expected returns. Our strategy is contrary to conventional wisdom because it takes relatively less risk in recessions and crises yet still earns high average returns. This rules out typical risk-based explanations and is a challenge to structural models of time-varying expected returns.
Number of Pages in PDF File: 70
Date posted: September 12, 2015 ; Last revised: October 28, 2016