Robustness of stable volatility strategies

Nicole Branger, Antje Mahayni and Daniel Zieling

Journal of Economic Dynamics and Control, 2015, vol. 60, issue C, 134-151

Abstract: The paper analyzes the robustness of stable volatility strategies, i.e. strategies in which the portfolio weight of the stock is inversely proportional to its local volatility. These strategies are optimal for a CRRA investor if the stock follows a diffusion process, the expected excess return is proportional to its volatility, and the hedging demand is zero. We assess the performance of stable volatility strategies when these restrictive assumptions do not hold, in particular, when the risk premium is not proportional to volatility and when the stock price is subject to jumps. We find that stable volatility strategies are indeed robust or close to robust under a maxmin decision rule. In addition to our theoretical results, we perform a simulation analysis to evaluate strategies that scale the portfolio weight by the volatility, variance or a constant portfolio weight, and also analyze the strategies using empirical excess returns. Both analyses confirm the robustness of stable volatility strategies.

Keywords: Stable volatility strategies; Jump diffusion processes; Model risk; Robustness; Performance evaluation (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:60:y:2015:i:c:p:134-151

DOI: 10.1016/j.jedc.2015.08.007

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