Direct and Indirect Volatility Timing Strategies

14 Pages Posted: 28 Aug 2024

See all articles by Xiaodu Xie

Xiaodu Xie

Queensland University of Technology

Abstract

Recent studies have challenged the usefulness of variance/covariance forecasting for the purpose of Global Minimum Variance Portfolio (GMVP) construction, instead advocating the direct forecasting of realized weights. This study examines the value of this direct approach when dimension reduction is handled in the portfolio construction problem via popular volatility timing strategies. In an empirical analysis of US stocks, we find higher out-of-sample portfolio Sharpe ratios from the traditional indirect approach relying on volatility forecasts, even when accounting for high levels of transaction costs. These results demonstrate the continued usefulness of volatility forecasting models in portfolio construction.

Keywords: Portfolio Optimization, Volatility Timing, Forecasting, HAR, RV

Suggested Citation

Xie, Xiaodu, Direct and Indirect Volatility Timing Strategies. Available at SSRN: https://ssrn.com/abstract=4939816 or http://dx.doi.org/10.2139/ssrn.4939816

Xiaodu Xie (Contact Author)

Queensland University of Technology ( email )

2 George Street
Brisbane, 4000
Australia

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