Return Premiums in Volatility-Managed Portfolios - Evidence from Norway and international equity markets

Abstract

We scale portfolios by the inverse of their previous month’s realized variance to create volatility-managed portfolios. Our managed portfolios reduce market exposure when volatility is high and vice versa. We analyse the strategy's performance on portfolios constructed on various risk factors in the Norwegian and U.S. stock markets. Our results show that volatility-managing lead to improved returns for six out of eight portfolios. The strategy significantly reduces drawdowns during market turmoil while also amplifying returns through increased market exposure during calm markets. Volatility-managing performs well during most economic crises. However, the strategy shows ambiguous performance in the aftermath of the COVID-19 market crash, as only half of the portfolios outperform their unmanaged counterparts. We also provide international evidence of return premiums when applying the strategy to portfolios constructed on momentum. The superior risk-adjusted returns challenge the linear risk-return relationship in the capital asset pricing model.