Tail Risk Mitigation with Managed Volatility Strategies
53 Pages Posted: 22 Nov 2017
Date Written: November 10, 2017
Managed Volatility Strategies adjust exposures in inverse relation to a risk estimate, aiming to stabilize realized portfolio volatility through time. While volatility stabilization is achievable with relative ease (owing to the general predictability of volatility, or volatility clustering, and mean reversion), it is not by itself an obvious benefit for investors. Our paper examines managed volatility performance under a range of success metrics that align with how investment practitioners often evaluate investment strategies. Using long term daily return data for the S&P 500, we show that while managed volatility is only associated with a small improvement in risk-adjusted return, it produces robust enhancements in tail risk reduction. We illustrate these enhancements via utility based metrics that reward the tail risk reduction emanating from the volatility stabilization inherent to the strategy. As practitioners, we have also noticed that individual investors intuitively view the volatility stabilization characteristic as a benefit, while professional fundamental investors sometimes view the momentum-like trading pattern under certain market environments as a deterrent. We resolve some of this tension by applying different metrics to a range of investor time horizons or holding periods.
Keywords: Volatility Management, Volatility, Risk Management, Tail Risk Mitigation, Utility
JEL Classification: C1, C5, C50, G02, G11
Suggested Citation: Suggested Citation