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The Volatility Effect: Lower Risk without Lower Return

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  • Blitz, D.C.
  • van Vliet, P.

Abstract

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.

Suggested Citation

  • Blitz, D.C. & van Vliet, P., 2007. "The Volatility Effect: Lower Risk without Lower Return," ERIM Report Series Research in Management ERS-2007-044-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
  • Handle: RePEc:ems:eureri:10460
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    File URL: https://repub.eur.nl/pub/10460/ERS-2007-044-F&A.pdf
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    References listed on IDEAS

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    1. Shefrin, Hersh & Statman, Meir, 2000. "Behavioral Portfolio Theory," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(2), pages 127-151, June.
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    Keywords

    CAPM; Fama-French factors; alpha; international; low risk stocks; strategic asset allocation; volatility; volatility effect;

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures
    • M - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics

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