TY - JOUR
T1 - Conditional risk and performance evaluation
T2 - Volatility timing, overconditioning, and new estimates of momentum alphas
AU - Boguth, Oliver
AU - Carlson, Murray
AU - Fisher, Adlai
AU - Simutin, Mikhail
N1 - Funding Information:
We received helpful comments from an anonymous referee, Jonathan Berk, Ekkehart Boehmer, Long Chen, Zhi Da, Engelbert Dockner, Wayne Ferson, Lorenzo Garlappi, Ron Giammarino, Ro Gutierrez, Cam Harvey, Ravi Jagannathan, Marcin Kacperczyk, Jonathan Lewellen, Stefan Nagel, Jacob Sagi, Jay Shanken, Rob Stambaugh, Steve Thorley, Keith Vorkink, Kevin Wang, Moto Yogo, and seminar participants at Brigham Young University, HEC Lausanne, New York University, Rice University, Texas A&M, University of British Columbia, University of California at Los Angeles, University of Minnesota, University of Vienna, the 2007 fall meeting of the National Bureau of Economic Research Asset Pricing Program, the 2007 Northern Finance Association Conference, and the 2009 Western Finance Association Conference. We gratefully acknowledge support from the Social Sciences and Humanities Research Council of Canada and the Bureau of Asset Management at the University of British Columbia.
Copyright:
Copyright 2011 Elsevier B.V., All rights reserved.
PY - 2011/11
Y1 - 2011/11
N2 - Unconditional alphas are biased when conditional beta covaries with the market risk premium (market timing) or volatility (volatility timing). We demonstrate an additional bias (overconditioning) that can occur any time an empiricist estimates risk using information, such as a realized beta, that is not available to investors ex ante. Calibrating to U.S. equity returns, volatility timing and overconditioning can plausibly impact alphas more than market timing, which has been the focus of prior literature. To correct market- and volatility-timing biases without overconditioning, we show that incorporating realized betas into instrumental variables estimators is effective. Empirically, instrumentation reduces momentum alphas by 20-40%. Overconditioned alphas overstate performance by up to 2.5 times. We explain the sources of both the volatility-timing and overconditioning biases in momentum portfolios.
AB - Unconditional alphas are biased when conditional beta covaries with the market risk premium (market timing) or volatility (volatility timing). We demonstrate an additional bias (overconditioning) that can occur any time an empiricist estimates risk using information, such as a realized beta, that is not available to investors ex ante. Calibrating to U.S. equity returns, volatility timing and overconditioning can plausibly impact alphas more than market timing, which has been the focus of prior literature. To correct market- and volatility-timing biases without overconditioning, we show that incorporating realized betas into instrumental variables estimators is effective. Empirically, instrumentation reduces momentum alphas by 20-40%. Overconditioned alphas overstate performance by up to 2.5 times. We explain the sources of both the volatility-timing and overconditioning biases in momentum portfolios.
KW - Conditional CAPM
KW - Momentum
KW - Performance evaluation
KW - Volatility timing
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U2 - 10.1016/j.jfineco.2011.06.002
DO - 10.1016/j.jfineco.2011.06.002
M3 - Article
AN - SCOPUS:80052759926
SN - 0304-405X
VL - 102
SP - 363
EP - 389
JO - Journal of Financial Economics
JF - Journal of Financial Economics
IS - 2
ER -