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Volatility

Volatility and the Sharpe Ratio in the Equity Markets in the Covid-19 Era

Assessing the low volatility anomaly on stock returns during a pandemic

This paper investigates stock returns and the Sharpe Ratio in the United States and other geographic regions for different volatility portfolios for the period of 2020-2021, which is an economic period heavily affected by the Covid-19 pandemic. It finds that the low volatility anomaly is not observed in this period, which marks a shift of regime from previous years. However, the Sharpe Ratio still presents a tendency to decrease as the volatility increases.

  • “While low volatility companies did not perform in line with expectations, other factors did perform well. In this period, we saw the StarMine Analyst Revisions model (ARM) returning 30.2% in the top decile and a decile spread of 18.4%.”
  • "An assessment of the Sharpe Ratio for different volatility portfolios against a stock universe consisting of 9,000 securities with the highest capitalization for each region."
  • "The universe utlised is resampled quarterly to avoid look ahead and survivorship bias."

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The unique nature of this crisis shut down many traditional business activities and rewarded companies that exist in the cloud and do not rely on a physical presence, mainly the tech industry. In a period of economic turmoil, or at least in one that resembles the economy during the COVID-19 pandemic, the low volatility strategy should be avoided, but on a risk adjusted basis, the low volatility portfolios still present a better performance than those with the highest volatility.

Key content

"For the U.S. and most of the regions around the world, the return quintile spread is positive, in contrast to what we would expect if the low volatility anomaly was observed."

"Excluding Developed Asia ex-Japan, the quintile spread of the Sharpe Ratio is negative showing that largest volatility band has a smaller Sharpe Ratio than the lowest volatility band."

"During the COVID-19 pandemic low volatility portfolios still present a better performance than those with the highest volatility."