Conditional Volatility Targeting
Financial Analysts Journal, 2020, 76(4): 54–71
32 Pages Posted: 20 Jul 2020 Last revised: 9 Nov 2020
Date Written: June 17, 2020
We analyze the performance of volatility targeting strategies. Conventional volatility targeting fails to consistently improve performance in global equity markets and can lead to markedly greater draw-downs. Motivated by return patterns in different volatility states, we propose a conditional volatility targeting strategy that only adjusts risk exposures in the extremes during high and low volatility states. This strategy consistently enhances Sharpe ratios and reduces draw-downs and tail risks for major equity markets and momentum factors across regions, with low turnover and leverage. Conditional volatility management can also be applied to tactical allocation between multiple assets or risk factors.
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