Managing Portfolio Volatility

Abstract

The authors revisit asset allocation strategies that aim at actively managing the volatility of multi-asset-class portfolios in response to time-varying volatility forecasts. They use the historical data of 29 major market indexes covering global equities, bonds, currencies, and commodities and apply a common set of exponentially weighted volatility estimates to them. The authors find that active volatility management is beneficial for most of these asset classes and for mixed asset portfolios, leading to more consistent wealth accumulation over time. In cross-validations, they find that fast-moving volatility forecasts seem beneficial because they have better forecasting accuracy and produce economic gains in terms of risk accuracy and performance. The authors also find significant reduction of tail risks for most assets, except for bonds, where the reduction is minor.

TOPICS: Portfolio construction, volatility measures, risk management, tail risks, performance measurement

Key Findings

• ▪ We find that active volatility management is beneficial for many major asset classes and for mixed asset portfolios, leading to more consistent wealth accumulation over time.

• ▪ In cross-validations, we find that fast-moving volatility forecasts seem beneficial because they have better forecasting accuracy and produce economic gains in terms of risk accuracy and performance.

• ▪ We also find significant reduction of tail risks for most assets, except for bonds, where the reduction is minor.