Tail Risk Mitigation with Managed Volatility Strategies

Dreyer, Anna and Hubrich, Stefan, Tail Risk Mitigation with Managed Volatility Strategies (April 16, 2019). Journal of Investment Strategies 8(1), 29-56.

28 Pages Posted: 22 Nov 2017 Last revised: 13 Jun 2019

Date Written: November 10, 2017

Abstract

Managed volatility strategies adjust market exposure in inverse relation to a risk estimate, to stabilize realized portfolio volatility through time. Our paper examines strategy performance from an investment practitioner perspective. Using long-term data from the Standard & Poor’s 500, we show that these strategies offer an improvement in risk-adjusted return compared with a buy-and-hold benchmark, on average, but with some variation. Managed volatility strategies achieve robust tail-risk reduction while also enhancing skewness. These return normalization features are inherently linked to the nature of the volatility stabilization mechanism. We illustrate them via utility-based metrics that reward the tail-risk reduction emanating from volatility stabilization. These enhancements are economically meaningful for many time horizons and holding period combinations, and they remain once transaction costs have been included, suggesting a durable and tangible value-add from managed volatility strategies. They also suggest a more appropriate way to measure the performance improvements of tail-risk-mitigating strategies.

Keywords: Volatility Management, Volatility, Risk Management, Tail Risk Mitigation, Utility

JEL Classification: C1, C5, C50, G02, G11

Suggested Citation

Dreyer, Anna and Hubrich, Stefan, Tail Risk Mitigation with Managed Volatility Strategies (November 10, 2017). Dreyer, Anna and Hubrich, Stefan, Tail Risk Mitigation with Managed Volatility Strategies (April 16, 2019). Journal of Investment Strategies 8(1), 29-56.. Available at SSRN: https://ssrn.com/abstract=3074529 or http://dx.doi.org/10.2139/ssrn.3074529

Anna Dreyer (Contact Author)

T. Rowe Price ( email )

100 E. Pratt Street
Baltimore, MD 21202
United States
410-345-2887 (Phone)

Stefan Hubrich

T.Rowe Price ( email )

100 East Pratt Street
Baltimore, MD 21202
United States
410.345.2169 (Phone)

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