The Economic Value of Volatility Timing Using 'Realized' Volatility
Rice University, Jones Graduate School Working Paper
48 Pages Posted: 21 Jul 2001
Date Written: December 29, 2001
Recent work suggests that intradaily returns can be used to construct estimates of daily return volatility that are more precise than those constructed using daily returns. We measure the economic value of this "realized" volatility approach in the context of investment decisions. Our results indicate that the value of switching from daily to intradaily returns to estimate the conditional covariance matix can be substantial. We estimate that a risk-averse investor would be willing to pay 50 to 200 basis points per year to capture the observed gains in portfolio performance. Moreover,these gains are robust to transaction costs, estimation risk regarding expected returns, and the performance measurement horizon.
Keywords: Realized volatility, volatility timing, tactical asset allocation, portfolio optimization, mean-variance analysis
JEL Classification: G11, C14
Suggested Citation: Suggested Citation