The volatility effect across size buckets: evidence from the Indian stock market

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The portfolio of low-volatility stocks earns high risk-adjusted returns over a full market cycle. The annual alpha spread of low versus high-volatility quintile portfolios is 25.53% in the Indian equity market for the period from January 2000 to September 2018. The low-volatility (LV) effect is not an overlap of other established factors such as size, value or momentum. The effect persists across various size buckets (market capitalization). The performance of the low-volatility effect within various size buckets is analyzed using three different portfolio formation methods. Irrespective of the method of portfolio construction, the low-volatility effect exists and it also generates economically and statistically significant risk-adjusted returns. The long-short portfolios across the study deliver exceptionally high and statistically significant returns accompanied by negative beta. The low-volatility effect is not restricted to small or illiquid stocks. The effect delivers the highest risk-adjusted returns for the portfolio consisting of largecap stocks. Though the returns of the portfolio comprising of large-cap LV stocks are lower than the returns of the portfolio comprising of small-cap LV stocks, its Sharpe ratio is higher because of less risky nature of large-cap stocks as compared to small-cap stocks. The LV portfolio majorly comprises of large-cap, growth and winner stocks. But within size buckets, large-cap and mid-cap low LV picks growth and winner stocks, while small-cap LV picks value stocks.

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    • Figure 1. Indian mutual fund industry – assets under management
    • Figure 2. Comparison of returns from Nifty Low-Volatility 50 Index and Nifty 50 Index
    • Figure 3A. Descriptive statistics – no. of stocks
    • Figure 3B. Descriptive statistics – total market capitalization
    • Table 1. Risk and return of volatility ranked portfolios
    • Table 2. CAPM style alpha, three-factor alpha and four-factor alpha of volatility ranked portfolios
    • Table 3. Three-factor and four-factor regression coefficients of volatility extreme portfolios
    • Table 4. Excess returns of independent sort portfolios on size and volatility
    • Table 5. Ex-post beta ratio of quintile portfolios independently sorted on size and volatility
    • Table 6. Sharpe ratio of quintile portfolios independently sorted on size and volatility
    • Table 7. CAPM style alpha of quintile portfolios independently sorted on size and volatility
    • Table 8. Three factor alpha of quintile portfolios independently sorted on size and volatility
    • Table 9. Four factor alpha of quintile portfolios independently sorted on size and volatility
    • Table 10. Regression coefficient analysis of three-factor (Fama-French) alpha of portfolios independently sorted on size and volatility with their corresponding t-value
    • Table 11. Regression coefficient analysis of three-factor (Fama-French) alpha of portfolios independently sorted on size and volatility with their corresponding t-value
    • Table 12. Risk and return of dependent portfolios sorted on volatility and controlled for size
    • Table 13. CAPM style alpha, three-factor and four-factor alpha of volatility ranked portfolios controlled for size
    • Table 14. Three-factor and four-factor regression coefficients dependent portfolios ranked on volatility and controlled for size
    • Table 15. Risk and return of large-cap, mid-cap and small-cap stocks sorted on historical volatility
    • Table 16. CAPM style alpha, three-factor alpha and four-factor alpha of volatility ranked portfolios within various size buckets
    • Table 17. Three-factor and four-factor regression coefficients of volatility ranked portfolios of largecap, mid-cap and small-cap stocks