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The Determinants of Volatility Timing Performance

Author

Listed:
  • Nick Taylor
Abstract
The exact conditions under which volatility timing strategies yield value are documented. These conditions include: the ability to correctly forecast next period stochastic variance, and violation of a strict version of Merton’s intertemporal capital asset pricing model (ICAPM). While the empirical evidence supports the first of these conditions, the latter remains open to debate. Our empirical results confirm the former, but demonstrate a significant violation of the (strict) ICAPM. It follows that volatility timing strategies appear to have value. However, using reasonable parameter values plugged into the derived formulae, the results also show that extreme leverage is often required for success. A method of tempering leverage is proposed, which is somewhat able to loosen the requirement of high leverage while still maintaining a good performance level. Given the likely variation in (strict) ICAPM violations across time and assets, it follows that volatility timing success (or failure) is very much sample dependent.

Suggested Citation

  • Nick Taylor, 2023. "The Determinants of Volatility Timing Performance," Journal of Financial Econometrics, Oxford University Press, vol. 21(4), pages 1228-1257.
    • Handle: RePEc:oup:jfinec:v:21:y:2023:i:4:p:1228-1257.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbac002
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    financial forecasting; forecasting skill; performance fees; risk preference; volatility timing;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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