Volatility Managed Multi-Factor Portfolios

Vol. 23, No. 3, 2025
By Christoph Reschenhofer and Josef Zechner

This paper demonstrates that portfolio performance can be substantially enhanced by simultaneously utilizing historical factor return volatilities and option-derived market volatilities to optimize factor exposures. The improvements are particularly pronounced in regimes where option-implied market returns exhibit high volatility and right-skewness. Further gains in risk-adjusted portfolio returns are achieved by estimating model parameters separately for different regimes. Qualitatively similar results are obtained when all parameters are estimated strictly out-of-sample. These findings are not limited to a specific set of factors; comparable enhancements are observed when employing principal components derived from a broad set of factors.