2008 May 30 - Fri
The Joy of Volatility
I initially had this embedded in my follow on article, but I think the information in
this paper bears further scrutiny and testing, in regards to what could be classified as
what I think is called pairs trading. I guess the secret is in the selection of the pairs.
The paper is by
Dempster/Evstigneev/Schenk-Hoppé, and called
The Joy of
Volatility. They take a coin flipping strategy to picking a couple of assets. They
show that the volatility is a positive benefit to portfolio profitability in a dynamic
rebalancing strategy versus a buy and hold mentality. A couple of key quotes though:
Poverty is the inevitable fate of the passive investor.
Consider making an investment according to a simple active management style:
buying or selling assets so as to always maintain an equal investment in both. On average,
wealth will double in 80 periods and grow without limits. This investment style rebalances
wealth according to a constant proportions strategy. It succeeds, where buy-and-hold fails,
because of the volatility of asset returns.
However, as with any investment advice, a word of caution is in order:
Constant proportions strategies do well in the long term but, over short time horizons,
their superior performance cannot be guaranteed!
|
