The Volatility Effect Revisited

High-risk stocks do not have higher returns than low-risk stocks in all major stock markets. This article provides a comprehensive overview of this low-risk effect, from the earliest asset pricing studies in the 1970s to the most recent empirical findings and interpretations. Volatility appears to be the main driver of the anomaly, which is highly persistent over time and across markets and which cannot be explained by other factors such as value, profitability, or exposure to interest rate changes. From a practical perspective, low-risk investing requires little turnover, volatilities are more important than correlations, low-risk indexes are suboptimal and vulnerable to overcrowding, and other factors can be efficiently integrated into a low-risk strategy. Finally, there is little evidence that the low-risk effect is being arbitraged away because many investors are either neutrally positioned or even on the other side of the low-risk trade.