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The impact of volatility scaling on factor portfolio performance and factor timing

Author

Listed:
  • Federico Nucera

    (Bank of Italy)

  • Björn Uhl

    (Pinechip Capital GmbH)

Abstract

This paper investigates the effects of volatility scaling on factor portfolio performance and factor timing. We focus on the four equity factors analyzed by Carhart (1997) and find that volatility scaling may lead to higher diversification benefits for a long-horizon investor when equity factors are combined into a portfolio. Depending on the portfolio formation methodology, we also discover a substantial time-variation in portfolio performance. In addition, our results show that volatility scaling improves factor return predictability, but this does not necessarily translate into a profitable factor rotation strategy.

Suggested Citation

  • Federico Nucera & Björn Uhl, 2022. "The impact of volatility scaling on factor portfolio performance and factor timing," Journal of Asset Management, Palgrave Macmillan, vol. 23(6), pages 522-533, October.
    • Handle: RePEc:pal:assmgt:v:23:y:2022:i:6:d:10.1057_s41260-022-00279-9
    DOI: 10.1057/s41260-022-00279-9
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    References listed on IDEAS

    as
    1. Moskowitz, Tobias J. & Ooi, Yao Hua & Pedersen, Lasse Heje, 2012. "Time series momentum," Journal of Financial Economics, Elsevier, vol. 104(2), pages 228-250.
    2. repec:dau:papers:123456789/4688 is not listed on IDEAS
    3. Barroso, Pedro & Detzel, Andrew, 2021. "Do limits to arbitrage explain the benefits of volatility-managed portfolios?," Journal of Financial Economics, Elsevier, vol. 140(3), pages 744-767.
    4. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    5. Barroso, Pedro & Santa-Clara, Pedro, 2015. "Momentum has its moments," Journal of Financial Economics, Elsevier, vol. 116(1), pages 111-120.
    6. Cederburg, Scott & O’Doherty, Michael S. & Wang, Feifei & Yan, Xuemin (Sterling), 2020. "On the performance of volatility-managed portfolios," Journal of Financial Economics, Elsevier, vol. 138(1), pages 95-117.
    7. Alan Moreira & Tyler Muir, 2017. "Volatility-Managed Portfolios," Journal of Finance, American Finance Association, vol. 72(4), pages 1611-1644, August.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Volatility scaling; Equity factors; Portfolio formation; Diversification benefits; Factor timing;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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