Low Volatility Investing

We examine the short-duration premium using pre-scheduled economic, monetary policy, and earnings announcements. We provide high-frequency evidence that duration premia associated with revisions of economic growth and interest rate expectations are consistent with asset pricing models but cannot explain the short-duration premium. Instead, we show that the trading activity of sentiment-driven investors raises prices of long-duration stocks, which lowers their expected returns, and results in the short-duration premium. Long-duration stocks have the lowest institutional ownership, exhibit the largest forecast errors at earnings announcements, and show the highest mispricing scores.

The superior performance of low-volatility stocks was first documented in the literature in the 1970s—by Fischer Black in 1972, among others —even before the size and value  premiums were “discovered.” The low-volatility anomaly has been shown to exist in equity markets around the world. Interestingly, this finding is true not only for stocks but for bonds as well. In other words, it has been pervasive...but

One of the big problems for the first formal asset pricing model developed by financial economists, the CAPM, was that it predicts a positive relationship between risk and return. However, empirical studies have found the actual relationship to be basically flat, or even negative. Over the last 50 years, the most “defensive” (low-volatility or low-beta, low-risk) stocks have delivered both higher returns and higher risk-adjusted returns than the most “aggressive” (high-volatility, high-risk) stocks.

Two of the more interesting puzzles in finance are the high beta anomaly (high beta stocks have lower returns) and the IVOL anomaly (stocks with [...]