Timing Idiosyncratic Volatility and Dynamic Asset Allocation

Yun Shi

No 9kber, SocArXiv from Center for Open Science

Abstract: We solve a portfolio selection problem when both expected return, idiosyncratic volatility, and transaction cost are time-varying. Our optimal strategy suggests trading partially toward a dynamic aim portfolio, which is a weighted average of expected future tangency portfolio and is highly influenced by the common fluctuation of idiosyncratic volatility (CIV). When CIV is high, the investor would invest less and trade less frequently to avoid risk and transaction cost. Moreover, the investor trades more closely to the aim portfolio with a more persistent CIV signal. Our strategy outperforms alternative strategies empirically and the benefits mainly come from timing idiosyncratic volatility.

Date: 2020-04-06
New Economics Papers: this item is included in nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:osf:socarx:9kber

DOI: 10.31219/osf.io/9kber

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