The Long and Short of the Vol Anomaly
- Jordan and Riley
- A version of the paper can be found here.
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On average, stocks with high prior-period volatility underperform those with low prior-period volatility, but that comparison is misleading. As we show, high volatility is an indicator of both positive and negative future abnormal performance. Among high volatility stocks, those with low short interest actually experience extraordinary positive returns, while those with high short interest experience equally extraordinary negative returns. The fact that publicly available information on aggregate short selling can be used to predict positive and negative abnormal returns of great magnitude points to a large-scale market inefficiency. Further, based on the evidence in this study, the current “low vol” investing fad has little or no real foundation.
The authors remind everyone of the new “fad” in investing: low volatility investing. As other papers show, low volatility investing has outperformed in the past:
However, investors should proceed with caution.
Combining another common measure–short interest for a stock–with volatility produces some intriguing results.
The chart below shows that the best performing portfolio goes long firms with HIGH volatility and low short interest!!!
Two explanations from the authors to describe these returns:
- Omitted systematic risk factor, or…
- Misvaluation exists and short sellers are good at identifying potential problems on the horizon.
Overall, whenever one variable (short interest) can ruin a strategy (low volatility), it highlights a robustness issue.
Here are some ETFs focused on low/min volatility if you’re interested in who is datamining.
Time to go buy a low volatility ETF?