Comonotonicity and low volatility effect

Discussions on low volatility effects often highlight the advantage of low volatility stocks outperforming high volatility stocks. Using comonotonicity tests, our study provides evidence of the downside of this effect: stock returns do not increase monotonically with low volatility, but volatility i...

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Bibliographic Details
Published in:Annals of operations research 2021-04, Vol.299 (1-2), p.1057-1099
Main Authors: Lai, Wan-Ni, Chen, Yi-Ting, Sun, Edward W.
Format: Article
Language:English
Subjects:
Analysis
Business and Management
Combinatorics
Economic aspects
Economic models
Empirical analysis
Industrial nations
Influence
Monotonic functions
Operations research
Operations Research/Decision Theory
Risk
S.I.: Recent Developments in Financial Modeling and Risk Management
Stock markets
Theory of Computation
Volatility
Volatility (Finance)
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Summary:Discussions on low volatility effects often highlight the advantage of low volatility stocks outperforming high volatility stocks. Using comonotonicity tests, our study provides evidence of the downside of this effect: stock returns do not increase monotonically with low volatility, but volatility increases monotonically with specific risks. We find that, counterintuitively, the low volatility effect is mostly driven by high volatility stocks with high specific risks. Our empirical analysis addresses a cross section of stock returns across 23 developed countries and employs comonotonicity tests to show that expected stock returns do not increase monotonically with lower volatility. In addition, by decomposing volatility into its individual risk components, we show that volatility increases monotonically with its specific risk component. Finally, we also confirm that returns obtained from the low volatility effect in stocks are principally driven by the specific risk component rather than the systematic risk component.
ISSN:0254-5330
1572-9338
DOI:10.1007/s10479-019-03320-0