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.

CAPM, Fama-French factors, alpha, international, low risk stocks, strategic asset allocation, volatility, volatility effect
Corporate Finance and Governance (jel G3), Infrastructures; Other Public Investment and Capital Stock (jel H54), Business Administration and Business Economics; Marketing; Accounting (jel M)
Erasmus Research Institute of Management
hdl.handle.net/1765/10460
ERIM Report Series Research in Management
ERIM report series research in management Erasmus Research Institute of Management
Erasmus Research Institute of Management

Blitz, D.C, & van Vliet, P. (2007). The Volatility Effect: Lower Risk without Lower Return (No. ERS-2007-044-F&A). ERIM report series research in management Erasmus Research Institute of Management. Erasmus Research Institute of Management. Retrieved from http://hdl.handle.net/1765/10460