Abstract
We provide evidence of the volatility effect from the Indian markets using the universe of past and present constituents of Nifty 500 index of National Stock Exchange (NSE). The results show that the portfolio consisting of low volatility stocks outperforms the portfolio consists of high volatility stocks and the market portfolio both in absolute and risk-adjusted terms. Further, we report that the volatility effect is a distinct effect. Size, value and momentum factors cannot explain the outperformance of low-volatility stocks. The risk anomaly is robust to the choice of risk measure; however, the volatility effect is stronger than the beta effect and it implies that both systematic risk and idiosyncratic risks contribute to the risk anomaly. The low-volatility portfolio has significant exposure to growth stocks, and it differs from the value tilt observed for low-volatility portfolios in developed markets.
Highlights
Finance theory postulates the positive relationship between risk and return
The risk anomaly is robust to the choice of risk measure; the volatility effect is stronger than the beta effect and it implies that both systematic risk and idiosyncratic risks contribute to the risk anomaly
This table reports the main results of univariate analysis including the table reports excess-monthly returns, annualized standard deviation, Sharpe ratio, t-statistics showing the significance of the difference of Sharpe ratio over the Universe, Realised beta and one-factor Capital Asset Pricing Model (CAPM) style alpha and maximum drawdown for decile portfolios constructed by sorting stocks based on the beta calculated using past three-year monthly returns
Summary
Finance theory postulates the positive relationship between risk and return. Modern portfolio theory [1] offers a model that allows investors to construct a portfolio that optimizes a risk-return trade-off consistent with risk tolerance. While the broad positive relationship holds true across asset classes, several studies across global markets report that portfolio constructed of least volatile stocks (or minimum variance portfolio), consistently outperforms the portfolio consisting of high volatility stocks and benchmark universe portfolio on a risk-adjusted basis and most times in absolute return terms over the full market cycle. These results challenged the positive relationship between risk and expected return as proposed by classic asset pricing theories.
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