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The Volatility Effect: Lower Risk without Lower Return

David Blitz and Pim Vliet

ERIM Report Series Research in Management from 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

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.

Keywords: CAPM; Fama-French factors; alpha; international; low risk stocks; strategic asset allocation; volatility; volatility effect (search for similar items in EconPapers)
JEL-codes: G3 H54 M (search for similar items in EconPapers)
Date: 2007-07-04
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (103)

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