Conditional risk and performance evaluation: Volatility timing, overconditioning, and new estimates of momentum alphas

Oliver Boguth, Murray Carlson, Adlai Fisher, Mikhail Simutin

Research output: Contribution to journalArticle

32 Scopus citations

Abstract

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.

Original languageEnglish (US)
Pages (from-to)363-389
Number of pages27
JournalJournal of Financial Economics
Volume102
Issue number2
DOIs
StatePublished - Nov 1 2011

Keywords

  • Conditional CAPM
  • Momentum
  • Performance evaluation
  • Volatility timing

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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