Volatility-Managed Portfolio: Does It Really Work?

Abstract

In this article, the authors find that a typical application of volatility-timing strategies to the stock market suffers from look-ahead bias, despite existing evidence on the success of the strategies at the stock level. After correcting this bias, the strategy becomes very difficult to implement in practice because its maximum drawdown is 68%–93% in almost all cases. Moreover, the strategy outperforms the market only during the financial crisis period. The authors also consider three alternative volatility-timing strategies and find that they do not outperform the market either. Their results show that one cannot easily beat the market via timing the market alone.

TOPICS: Portfolio construction, statistical methods, risk management

Key Findings

• • A typical application of volatility-timing strategies to the aggregate stock market, instead of at the stock level, can be more susceptible to look-ahead bias.

• • After correcting the bias, the strategy is difficult to implement due to large drawdowns, and it performs poorly over time except during the recent financial crisis period when volatility is extremely high.

• • One cannot easily beat the market via volatility-timing the market alone.