RT Journal Article
SR Electronic
T1 The Impact of Volatility Targeting
JF The Journal of Portfolio Management
FD Institutional Investor Journals
SP 14
OP 33
DO 10.3905/jpm.2018.45.1.014
VO 45
IS 1
A1 Harvey, Campbell R.
A1 Hoyle, Edward
A1 Korgaonkar, Russell
A1 Rattray, Sandy
A1 Sargaison, Matthew
A1 Hemert, Otto Van
YR 2018
UL http://jpm.pm-research.com/content/45/1/14.abstract
AB Recent studies show that volatility-managed equity portfolios realize higher Sharpe ratios than portfolios with a constant notional exposure. The authors show that this result only holds for risk assets, such as equity and credit, and they link this finding to the so-called leverage effect for those assets. In contrast, for bonds, currencies, and commodities, the impact of volatility targeting on the Sharpe ratio is negligible. However, the impact of volatility targeting goes beyond the Sharpe ratio: It reduces the likelihood of extreme returns across all asset classes. Particularly relevant for investors, left-tail events tend to be less severe because they typically occur at times of elevated volatility, when a target-volatility portfolio has a relatively small notional exposure. We also consider the popular 60–40 equity–bond balanced portfolio and an equity–bond–credit–commodity risk parity portfolio. Volatility scaling at both the asset and portfolio level improves Sharpe ratios and reduces the likelihood of tail events.