Abstract
Modern portfolio theory is founded on an understanding of longitudinal volatility but it is the cross-sectional dispersion among investment returns that provide active portfolio managers with their competitive investment opportunities. The varying cross-sectional volatility in the South African equity market provides varying opportunity sets for active managers: the higher the cross-sectional volatility, the greater the opportunity for active risk taking, all other things being equal. This article argues that cross-sectional volatility must be considered hand-in-hand with risk limits and active risk targets when investment mandates are set and when mandated risk compliance is monitored.
Highlights
Sapra (2008), Ankrim and Ding (2002) and De Silva, Sapra and Thorley (2001), amongst others, point out that modern portfolio theory is founded on an understanding and an emphasis on time series or longitudinal volatility
When fund managers decide on how to allocate the finite pool of assets under their management among various investments, it is the cross-sectional dispersion of expected returns that is required in order to provide them with a reasonable opportunity for expressing relative preferences
Cross-sectional volatility and its changes are a good measure of the investment opportunity set for active managers
Summary
Modern portfolio theory is founded on an understanding of longitudinal volatility but it is the cross-sectional dispersion among investment returns that provide active portfolio managers with their competitive investment opportunities. The varying cross-sectional volatility in the South African equity market provides varying opportunity sets for active managers: the higher the cross-sectional volatility, the greater the opportunity for active risk taking, all other things being equal. This article argues that cross-sectional volatility must be considered hand-in-hand with risk limits and active risk targets when investment mandates are set and when mandated risk compliance is monitored
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