Volatility Harvesting in Theory and Practice

Abstract

Rebalancing is an important tool for managing risk in a portfolio. It can also be a source of return—the act of maintaining constant weights generates a buy-low, sell-high trading pattern which is designed to harvest extra return from the volatility of the underlying assets. The authors present a formula that decomposes the excess returns of a portfolio strategy versus the market into three terms: a volatility return, a dispersion return, and a drift return. This approach represents a new way of thinking about the benchmark-relative risks involved with rebalancing.