The Volatility Effect: Lower Risk without Lower Return
David C. Blitz and Pim van Vliet
ERIM REPORT SERIES RESEARCH IN MANAGEMENT
ERIM Report Series reference number
ERS-2007-044-F&A
Publication
July 2007
Number of pages
19
Persistent paper URL
Email address corresponding author
p.van.vliet@robeco.nl
Address
Erasmus Research Institute of Management (ERIM)
RSM Erasmus University / Erasmus School of Economics
Erasmus Universiteit Rotterdam
P.O.Box 1738
3000 DR Rotterdam, The Netherlands
Phone:
+ 31 10 408 1182
Fax:
+ 31 10 408 9640
Email:
info@erim.eur.nl
Internet:
www.erim.eur.nl
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RESEARCH IN MANAGEMENT
ABSTRACT AND KEYWORDS
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.
Free Keywords
alpha, strategic asset allocation, volatility, volatility effect, low risk stocks, CAPM, Fama-French
factors, international
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