Dynamic Volatility Management: From Conditional Volatility to Realized Volatility

Forthcoming, Journal of Investment Strategies

21 Pages Posted: 14 May 2019

See all articles by Rongju Zhang

Rongju Zhang

Commonwealth Scientific and Industrial Research Organization (CSIRO); Monash University - Monash Centre for Quantitative Finance and Investment Strategies

Nicolas Langrené

Government of the Commonwealth of Australia - CSIRO (Commonwealth Scientific and Industrial Research Organisation)

Yu Tian

Monash University

Zili Zhu

Government of the Commonwealth of Australia - CSIRO (Commonwealth Scientific and Industrial Research Organisation)

Date Written: March 20, 2019

Abstract

The volatility of concern in conventional volatility-managed strategies such as volatility-targeting strategy and mean-variance optimization is the expected conditional volatility. However for investors, it is the realized volatility that is important, because there is only one realization in the market. Simply managing the conditional volatility may not manage well the realized volatility of the actual portfolio performance. This article provides a multi-period strategy that directly manages the realized volatility over a long horizon. More specifically, the strategy maximizes the expected portfolio value subject to an upper cap on the realized volatility. Our out-of-sample backtesting results show that this novel strategy delivers higher risk-adjusted returns compared to the volatility-targeting strategy, and that it successfully caps the realized volatility below the targeted level. The results are consistent across twelve equity markets and five targeted volatility levels.

Keywords: volatility management, volatility target, realized volatility, multi-period portfolio management, least squares Monte Carlo

JEL Classification: G11, G17, C61, C63

Suggested Citation

Zhang, Rongju and Langrené, Nicolas and Tian, Yu and Zhu, Zili, Dynamic Volatility Management: From Conditional Volatility to Realized Volatility (March 20, 2019). Forthcoming, Journal of Investment Strategies, Available at SSRN: https://ssrn.com/abstract=3356434

Rongju Zhang (Contact Author)

Commonwealth Scientific and Industrial Research Organization (CSIRO) ( email )

Door 34, Goods Shed, Village Street
Docklands, VIC 3008
Australia
452204105 (Phone)

Monash University - Monash Centre for Quantitative Finance and Investment Strategies ( email )

9 Rainforest Walk
Clayton Campus
Monash University, Victoria 3800
Australia

Nicolas Langrené

Government of the Commonwealth of Australia - CSIRO (Commonwealth Scientific and Industrial Research Organisation) ( email )

Melbourne
Australia

Yu Tian

Monash University ( email )

Melbourne, Victoria VIC 3800
Australia

Zili Zhu

Government of the Commonwealth of Australia - CSIRO (Commonwealth Scientific and Industrial Research Organisation) ( email )

Gate 5 Normanby Road
Clayton
Melbourne, Australian Capital Territory 3168
Australia
61 3 95458003 (Phone)
61 3 9545 8080 (Fax)

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