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The Value of Low Volatility

Last Updated on 10 February, 2024 by Rejaul Karim

Embarking on a journey through financial phenomena, David Blitz delves into “The Value of Low Volatility.” As evidence mounts for a discernible low-volatility effect, Blitz navigates through the intricate tapestry of financial markets.

Intriguingly, the performance of U.S. low-volatility strategies since 1963 seems influenced by implicit exposures to the Fama-French value factor. Yet, this explanatory power falters pre-1963 for large-cap strategies and post-1984 for the broader market. Small-cap low-volatility strategies defy explanation by the value effect, unveiling a nuanced landscape.

Fama-MacBeth regressions affirm the low-volatility effect’s resilience across subsamples, challenging conventional wisdom. Blitz compellingly argues that this effect stands distinct, resilient even when juxtaposed with the venerable value effect. In unraveling the intricacies, the evidence converges, suggesting that the low-volatility effect holds its ground with a resilience that surpasses its counterparts.

Abstract Of Paper

The evidence for the existence of a distinct low-volatility effect is mounting. However, implicit exposures to the Fama-French value factor (HML) seem to explain the performance of straightforward U.S. low-volatility strategies since 1963. In this paper I show that the value effect can neither explain the performance of large-cap low-volatility strategies pre-1963, nor post 1984, when the Fama-French value factor itself ceased to be effective in the large-cap segment of the market. Moreover, the performance of small-cap low-volatility strategies cannot be explained by the value effect during any period. Fama-MacBeth regressions support the existence of a low-volatility effect for every subsample. Based on these results and various other arguments I conclude that there exists a distinct low-volatility effect which cannot be explained by the value effect. The combined evidence even appears to be stronger for the low-volatility effect than for the value effect.

Original paper – Download PDF

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Author

David Blitz
Robeco Quantitative Investments

Conclusion

In conclusion, the mounting evidence supporting the existence of a distinct low-volatility effect challenges conventional explanations tied to the Fama-French value factor. While implicit exposures to the value factor can account for the performance of straightforward U.S. low-volatility strategies since 1963, this explanation falls short when considering large-cap low-volatility strategies pre-1963 and post-1984.

Notably, the ineffectiveness of the Fama-French value factor in the large-cap segment during certain periods underscores the independence of the low-volatility effect. This autonomy is further affirmed by the performance of small-cap low-volatility strategies, which remains unexplained by the value effect throughout various periods.

Fama-MacBeth regressions across subsamples consistently support the existence of a distinct low-volatility effect, even surpassing the strength of the value effect in combined evidence. In essence, the value of low volatility stands as a robust and independent factor, contributing unique benefits to investment strategies.

Related Reading:

Low Volatility Needs Little Trading

The Profitability of Low Volatility

FAQ

1. What does the evidence presented by David Blitz suggest about the relationship between low volatility and the Fama-French value factor in U.S. low-volatility strategies since 1963?

The evidence suggests that implicit exposures to the Fama-French value factor (HML) can explain the performance of straightforward U.S. low-volatility strategies since 1963. However, the explanatory power of the value factor falls short when considering large-cap low-volatility strategies both pre-1963 and post-1984. This implies that while there is a connection between low volatility and the Fama-French value factor in certain contexts, the relationship is not universal across different time periods and market segments.

2. How does the performance of small-cap low-volatility strategies differ from large-cap strategies, and why does Blitz argue that the low-volatility effect is distinct and independent of the value effect?

Blitz highlights that the performance of small-cap low-volatility strategies cannot be explained by the value effect during any period. This suggests that the relationship between low volatility and the Fama-French value factor does not hold for small-cap stocks. The author argues that, based on various arguments and Fama-MacBeth regressions, there exists a distinct low-volatility effect that stands independently of the value effect. The autonomy of the low-volatility effect is particularly evident when considering different market segments and historical periods.

3. How do Fama-MacBeth regressions across subsamples contribute to the argument for the distinctiveness of the low-volatility effect, and what does the combined evidence suggest about the strength of the low-volatility effect compared to the value effect?

Fama-MacBeth regressions consistently support the existence of a distinct low-volatility effect across various subsamples. The combined evidence from these regressions suggests that the strength of the low-volatility effect appears to be even greater than that of the value effect. This reinforces the argument that low volatility is a robust and independent factor influencing investment strategies, providing unique benefits that go beyond explanations tied to the Fama-French value factor.

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