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SSRN-id2474856

SSRN-id2474856

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Published by dpbasic
Claude Erb
Claude Erb

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Published by: dpbasic on Aug 07, 2014
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08/13/2014

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Betting On “Dumb Volatility” With “Smart Beta”
Claude ErbTRJuly 30, 2014
 
Overview
It is possible that some investors make the “dumb mistake” of “buying high and selling low”
The footprints of the “dumb mistake” of “buying high and selling low” show up as “dumb volatility”
With
enough “dumb volatility” some smart beta strategies
that
aim to “buy low and sell high” may
boost returns by 2-4%
“Dumb volatility” might exploit the “behavior gap”,
a measure of
the consequences of “buying
high and selling
low”
Focusing on “live returns”, a “six factor” model suggests “dumb volatility” has not been driven by value or size plays
“Dumb volatility” smart beta strategies may have the same
risk-adjusted-returns but not the same dumb volatility risk
Some equally weighted “dumb volatility” smart beta strategies might already be facing capacity constraints
Investors
face a “dumb volatility frontier” offering more “return from dumb volatility” in exchange for more “dumb volatility”
2
 
Four “Dumb Volatility” Strategy Examples
“Dumb volatility” strategies that aim to “buy low and sell high” assume that prices revert to “value”
Each strategy asserts that its method of harvesting “dumb mistakes” is the best
Some strategies rebalance to equal weights and others rebalance to some proxy for “value”
Regardless of the rebalancing approach, each strategy seeks to monetize the “dumb mistakes” of others
3
FTSE RAFIEqual Weighted S&P 500Equal Weighted Russell 1000Shiller Barclays CAPE
Note: Research Affiliates has positioned itself as the smart beta “thought leader”. Of course a belief in mean reversion is n
ot proof of mean reversion. A belief in mean reversion is an explicit bet.

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