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The Volatility Effect Revisited

Last Updated on 10 February, 2024 by Rejaul Karim

Diving into the heart of market dynamics, “The Volatility Effect Revisited” by David Blitz, Pim van Vliet, and Guido Baltussen navigates the intricate landscape of risk and return. Spanning from early asset pricing studies to contemporary empirical insights, the paper illuminates a compelling paradox: high-risk stocks do not necessarily yield higher returns across major global markets.

Delving deep into the low-risk effect, the researchers identify volatility as its linchpin—a persistent anomaly defying conventional explanations tied to factors like value or profitability. Offering practical insights, the study advocates for low-risk investing strategies, emphasizing the significance of volatilities over correlations.

It challenges the efficacy of low-risk indices, highlighting their vulnerability to overcrowding, and explores the coexistence of the low-risk effect, debunking notions of its imminent arbitrage.

Abstract Of Paper

High-risk stocks do not have higher returns than low-risk stocks in all major stock markets. This paper provides a comprehensive overview of this low-risk effect, from the earliest asset pricing studies in the nineteen seventies to the most recent empirical findings and interpretations since. Volatility appears to be the main driver of the anomaly, which is highly persistent over time and across markets, and which cannot be explained by other factors such as value, profitability, or exposure to interest rate changes. From a practical perspective we argue that low-risk investing requires little turnover, that volatilities are more important than correlations, that low-risk indices are suboptimal and vulnerable to overcrowding, and that other factors can be efficiently integrated into a low-risk strategy. Finally, we find little evidence that the low-risk effect is being arbitraged away, as many investors are either neutrally positioned, or even on the other side of the low-risk trade.

Original paper – Download PDF

Here you can download the PDF and original paper of The Volatility Effect Revisited.

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Author

David Blitz
Robeco Quantitative Investments

Pim van Vliet
Robeco Quantitative Investments

Guido Baltussen
Erasmus University Rotterdam (EUR); Northern Trust Corporation – Northern Trust Asset Management

Conclusion

In summary, the comprehensive analysis presented in this paper reaffirms the enduring nature of the low-risk effect across major stock markets. The research traces the evolution of this anomaly, from its early exploration in the seventies to contemporary empirical insights.

Notably, high-risk stocks do not consistently outperform low-risk counterparts, challenging traditional notions. Volatility emerges as the primary catalyst for this phenomenon, exhibiting persistence across time and markets, and resisting explanations based on other factors. The practical implications underscore the efficiency of low-risk strategies with minimal turnover, emphasizing the significance of volatilities over correlations.

Additionally, caution is advised against the potential drawbacks of overcrowded low-risk indices. The study concludes by dispelling notions of arbitrage erosion, highlighting the sustained relevance of the low-risk effect, with many investors remaining neutral or positioned against it.

Related Reading:

Low-Volatility Cycles: The Influence of Valuation and Momentum on Low-Volatility Portfolios

The Long and Short of the Vol Anomaly

FAQ

Q1: What is the main paradox discussed in “The Volatility Effect Revisited”?

A1: The paper explores the paradox that high-risk stocks do not necessarily yield higher returns across major global markets, challenging conventional wisdom. This is known as the low-risk effect.

Q2: What does the research identify as the main driver of the low-risk effect?

A2: The study identifies volatility as the primary driver of the low-risk effect. The anomaly is highly persistent over time and across markets, and it cannot be explained by other factors such as value, profitability, or exposure to interest rate changes.

Q3: What practical insights are provided in the paper for low-risk investing strategies?

A3: The paper offers practical insights, emphasizing that low-risk investing requires little turnover. It highlights the importance of volatilities over correlations, suggests that low-risk indices may be suboptimal and vulnerable to overcrowding, and advocates for the efficient integration of other factors into a low-risk strategy. Additionally, the research challenges the notion that the low-risk effect is being arbitraged away, as many investors remain neutral or positioned against it.

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