Volatility timing on the market, 2017 to 2025: a sixth less volatility, and the risk-adjusted return did not improve.

The idea worth investigating

Volatility timing is the rare academic result that practitioners already believed: take less risk after a volatile month, because volatility persists and expected returns do not rise to match. The question was never whether it lowers risk. It is whether it pays for itself.

We tested "Volatility-Managed Portfolios" by Alan Moreira and Tyler Muir, Journal of Finance, 2017. The authors scale monthly returns by the inverse of the previous month's realized variance and report large alphas and higher Sharpe ratios across the market, value, momentum, profitability, return on equity, investment and betting-against-beta factors, plus the currency carry trade. This is an older foundational paper, chosen to test our process on a result everyone cites.

The desk question: under one implementation fixed in advance, with leverage capped, borrowing charged and trading costs applied, does the market version improve the reward for risk in our retrospective 2017 to 2025 evaluation?

Here's the plan:

• 1. Calibrate the sizing constant on 1990 to 2016 market excess returns and freeze it.
• 2. Run January 2017 through December 2025, 108 monthly observations, with exposure capped at twice capital.
• 3. Charge five basis points per dollar traded, and price borrowed exposure at the risk-free rate plus 25 basis points.
• 4. Test a prespecified hurdle: a positive lower bound on both the spanning alpha and the Sharpe difference against a benchmark holding one unit of market exposure.

Scope: a completed market-only house adaptation using factor returns; it is not a direct reproduction of every experiment in the original paper.

Let's get started.

AI assists curation and drafting. The research status distinguishes paper reviews from house tests. Read our research approach.