Direct and Indirect Volatility Timing Strategies
14 Pages Posted: 28 Aug 2024
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: Suggested Citation