Forecasting skill and volatility timing performance
33 Pages Posted: 24 Nov 2020 Last revised: 11 Mar 2021
Date Written: October 3, 2020
The exact conditions under which volatility timing strategies yield value are documented. These conditions include: the ability to correctly forecast next period stochastic variance, and violation of Merton's ICAPM. Using reasonable parameter values plugged into the derived formulae, the results show that extreme leverage is often required for success. A method of tempering leverage is proposed, which is somewhat able to loosen the requirement of high leverage while still maintaining a good performance level.
Keywords: Volatility timing, forecasting skill, risk preference, performance fees.
JEL Classification: C22, C58, G11, G17
Suggested Citation: Suggested Citation