An Empirical Evaluation of Improved Volatility-Based Trading Strategies

Sammanfattning: In 2017, Moreira and Muir published their paper "Volatility-Managed Portfolios", showing that investors can beat the market, purely by choosing their risk exposure based on the inverse of last month's realized variance. While their results are influential in nature, suggesting, against common belief, investors should take less risk in recessions, they singularly rely on realized variance as a risk measure and a fixed monthly rebalancing period. Our paper, therefore, analyzes the effect of altering these prepositions by using more sophisticated variance estimation methods and by varying rebalancing periods on a fixed and a flexible basis. We show, that doing so can not only increase risk-adjusted outperformance, but also elicit desirable characteristics, like a lower tail risk, decreased transaction costs, and higher cumulative performance. Furthermore, we find that simpler methods of variance estimation seem to be on par with more complicated models and the predictive power of autoregressive models deteriorates with the length of the estimation period. Finally, we conclude, that the general strategy's alpha strongly depends on the occurrence of sustained market downturns like the Great Recession and that controlling for Business Cycles can explain its existence.