Conditional Risk and Performance Evaluation: Volatility Timing, Overconditioning, and New Estimates of Momentum Alphas

54 Pages Posted: 4 Jul 2007 Last revised: 7 May 2013

See all articles by Oliver Boguth

Oliver Boguth

Arizona State University (ASU) - Finance Department

Murray Carlson

University of British Columbia (UBC) - Sauder School of Business

Adlai J. Fisher

University of British Columbia (UBC) - Sauder School of Business

Mikhail Simutin

University of Toronto - Rotman School of Management

Date Written: November 1, 2011

Abstract

Unconditional alphas are biased when conditional beta covaries with the market risk premium (“market-timing”) or volatility (“volatility-timing”). We demonstrate an additional bias (“overconditioning”) that can occur any time an empiricist estimates risk using information, such as a realized beta, that is not available to investors ex ante. Calibrating to U.S. equity returns, volatility-timing and overconditioning can plausibly impact alphas more than markettiming, which has been the focus of prior literature. To correct market- and volatility-timing biases without overconditioning, we show that incorporating realized betas into instrumental variables estimators is effective. Empirically, instrumentation reduces momentum alphas by 20-40%. Overconditioned alphas overstate performance by up to 2.5 times. We explain the sources of both the volatility-timing and overconditioning biases in momentum portfolios.

Keywords: Overconditioning, Conditional CAPM, Performance Evaluation, Momentum

JEL Classification: G12

Suggested Citation

Boguth, Oliver and Carlson, Murray D. and Fisher, Adlai J. and Simutin, Mikhail, Conditional Risk and Performance Evaluation: Volatility Timing, Overconditioning, and New Estimates of Momentum Alphas (November 1, 2011). Journal of Financial Economics (JFE), 102 (2), 363-389, November 2011.. Available at SSRN: https://ssrn.com/abstract=998175

Oliver Boguth

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Murray D. Carlson (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8358 (Phone)

Adlai J. Fisher

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8331 (Phone)
604-822-4695 (Fax)

HOME PAGE: http://finance.sauder.ubc.ca/~fisher

Mikhail Simutin

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

HOME PAGE: http://www.rotman.utoronto.ca/simutin

Register to save articles to
your library

Register

Paper statistics

Downloads
676
Abstract Views
2,609
rank
37,425
PlumX Metrics