Factor/Style Investing

The Low-Volatility Anomaly: Market Evidence on Systemic Risk vs. Mispricing

Topics - Factor/Style Investing Defensive Volatility Market Risk and Efficiency

${ numberSection } ${ text }
The Low-Volatility Anomaly: Market Evidence on Systemic Risk vs. Mispricing

Researchers have demonstrated a long-term connection between future stock returns and various measures of prior stock price variability, including total return volatility, idiosyncratic volatility and beta. Specifically, in U.S. and international markets, future returns of previously low-return-variability portfolios significantly outperform those of previously high-return-variability portfolios.

These empirical findings are particularly intriguing because, of course, economic theory dictates that higher expected risk is compensated with higher expected return. As such, these findings highlight the need to gain a better understanding of the underpinnings of this curious anomaly.

We explore whether this anomaly associated with low-volatility stocks can be attributed to market mispricing or to compensation for higher systematic risk. Data from a 46-year study period (1966–2011), indicate that the high returns related to low-volatility portfolios cannot be viewed as compensation for systematic factor risk. Instead, they are more likely driven by market mispricing connected with volatility as a stock characteristic.

Published in

Financial Analysts Journal

AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which AQR.com has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.

 

The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.

 

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only.

 

Diversification does not eliminate the risk of experiencing investment loss.

 

Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.