
Equity alpha through volatility targeting
Volatility targeting has historically enhanced the statistical alpha of standard equity strategies. That is because volatility is more predictable in the short-term than returns. Thus, Sharpe ratios tend to decline, when volatility rises. Expected returns increase after turmoil but only overtime, when volatility might already be subsiding. On its own volatility is not a pure measure of risk premia and does not indicate if actual risk is overstated or underappreciated. A flipside of mechanical volatility targeting is that it contributes to herding and escalatory price dynamics.