The Volatility Effect: Lower Risk without Lower Return
2007-07-04
Research Paper
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We present empirical evidence that stocks with low volatility earn high risk-adjusted returns. The annual alpha spread of global low versus high volatility decile portfolios amounts to 12% over the 1986-2006 period. We also observe this volatility effect within the US, European and Japanese markets in isolation. Furthermore, we find that the volatility effect cannot be explained by other well-known effects such as value and size. Our results indicate that equity investors overpay for risky stocks. Possible explanations for this phenomenon include (i) leverage restrictions, (ii) inefficient two-step investment processes, and (iii) behavioral biases of private investors. In order to exploit the volatility effect in practice we argue that investors should include low risk stocks as a separate asset class in the strategic asset allocation phase of their investment process.
- international
- volatility
- CAPM
- Fama-French factors
- alpha
- low risk stocks
- strategic asset allocation
- volatility effect
- G3 : Corporate Finance and Governance
- M : Business Administration and Business Economics; Marketing; Accounting
- H54 : Infrastructures; Other Public Investment and Capital Stock
- volatility
- portfolio
- stock
- return
- volatility effect
- effect
- market
- decile
- risk stocks
- result
- decile portfolios
- sharpe
- ratio
- panel
- asset
- value
- deviation sharpe ratio
- investor
- sharpe ratio
- japan
