The Impact of Volatility Targeting

28 Pages Posted: 17 May 2018 Last revised: 11 Jul 2018

See all articles by Campbell R. Harvey

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Edward Hoyle

Man AHL

Russell Korgaonkar

Man AHL

Sandy Rattray

Man AHL

Matthew Sargaison

Man AHL

Otto Van Hemert

Man AHL

Date Written: June 25, 2018

Abstract

Recent studies show that volatility-managed equity portfolios realize higher Sharpe ratios than portfolios with a constant notional exposure. We show that this result only holds for “risk assets”, such as equity and credit, and link this to the so-called leverage effect for those assets. In contrast, for bonds, currencies, and commodities the impact of volatility targeting on the Sharpe ratio is negligible. However, the impact of volatility targeting goes beyond the Sharpe ratio: it reduces the likelihood of extreme returns, across all asset classes. Particularly relevant for investors, “left-tail” events tend to be less severe, as they typically occur at times of elevated volatility, when a target-volatility portfolio has a relatively small notional exposure. We also consider the popular 60-40 equity-bond “balanced” portfolio and an equity-bond-credit-commodity “risk parity” portfolio. Volatility scaling at both the asset and portfolio level improves Sharpe ratios and reduces the likelihood of tail events.

Keywords: volatility, volatility targeting, balanced fund, risk parity, asset allocation, portfolio choice

JEL Classification: E32, E44, G11, G12, G15, G17

Suggested Citation

Harvey, Campbell R. and Hoyle, Edward and Korgaonkar, Russell and Rattray, Sandy and Sargaison, Matthew and van Hemert, Otto, The Impact of Volatility Targeting (June 25, 2018). Available at SSRN: https://ssrn.com/abstract=3175538 or http://dx.doi.org/10.2139/ssrn.3175538

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

Edward Hoyle

Man AHL ( email )

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

Russell Korgaonkar

Man AHL ( email )

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

Sandy Rattray

Man AHL ( email )

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

Matthew Sargaison

Man AHL ( email )

Sugar Quay
Lower Thames Street
London, EC3R 6DU
Great Britain

Otto Van Hemert

Man AHL ( email )

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

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