How is Volatility Affecting Portfolios
(Second Quarter 2005)

The US stock market bubble and crash in the 1999-2000 period left many investors with a clear appreciation of just how volatile equities can be. But just a few years since, the market has gone eerily calm, and investors are loosening their aversion to risk in search for returns. With the equity market trending through most of 2004 and so far this year, the value/growth and large/small cap debates have subsided. Instead, investors are again talking about volatility, or rather the lack of it.

Is there more than one way to look at volatility ? Indeed there is. While together with asset correlations, volatility is the foundation of efficient frontiers and optimal portfolios, there is a new type of volatility gaining managers’ attention. This is stock volatility, also referred to in financial papers as cross-sectional volatility, dispersion, or idiosyncratic variety. Here, we will call the traditional notion of volatility as “time volatility” to differentiate it from the “stock volatility” that we will investigate further.

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