Managing Volatility to Suppress U.S. Stock Market Tail Risk

Do strategies that seek to exploit return volatility persistence by adjusting stock market exposure inversely with recent market volatility relative to some target (including exposures greater than 100%) produce obvious benefits for investors? In their November 2017 paper entitled “Tail Risk Mitigation with Managed Volatility Strategies”, Anna Dreyer and Stefan Hubrich examine usefulness of managing volatility in this way as applied to the S&P 500 Index over a long sample period and across a range of performance measurements. They use daily index returns in excess of the return on cash and rebalance stock index-cash test portfolios daily. Their target volatility is variable, set as the inception-to-date realized daily excess return volatility. They assess robustness across different sample subperiods, past volatility measurement intervals and portfolio holding intervals. They measure portfolio performance conventionally (Sharpe ratio), via effects on portfolio return distribution skewness and kurtosis (as an indicator of tail risk) and with investor utility metrics. Using daily excess returns for the S&P 500 Index during July 1926 through November 2016, they find that:

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