Conditional Volatility Targeting

Dion Bongaerts, Xiaowei Kang and Mathijs van Dijk

Financial Analysts Journal, 2020, vol. 76, issue 4, 54-71

Abstract: In analyzing the performance of volatility-targeting strategies, we found that conventional volatility targeting fails to consistently improve performance in global equity markets and can lead to markedly greater drawdowns. Motivated by return patterns in various volatility states, we propose a strategy of conditional volatility targeting that adjusts risk exposures only in the extremes during high- and low-volatility states. This strategy consistently enhances Sharpe ratios and reduces drawdowns and tail risks, with low turnover and leverage, when used in the major equity markets and for momentum factors across regions. Conditional volatility management can also be applied to tactical allocations among multiple assets or risk factors.Disclosure: The authors report no conflicts of interest. The views expressed in this article are those of the authors in their personal capacity and do not reflect the views of the Rotterdam School of Management or the Abu Dhabi Investment Authority. Editor’s Note Submitted 6 March 2020Accepted 23 June 2020 by Stephen J. BrownThis article was externally reviewed using our double-blind peer-review process. When the article was accepted for publication, the authors thanked the reviewers in their acknowledgments. Lisa Goldberg and one anonymous reviewer were the reviewers for this article.

Date: 2020
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DOI: 10.1080/0015198X.2020.1790853

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