Monday, October 1, 2012

When Russell 2000 is Low Vol

Continuing in my exploration of the Russell 2000 (Russell 2000 Softail Fat Boy), I thought I would try to approach the topic with a low volatility paradox mindset.  Since 2005, beta of the Russell 2000 compared to the S&P 500 has exceeded 1.2 with a max of 1.6 for almost every rolling 1 year period.  This suggests that the Russell 2000 is anything but low vol.

From TimelyPortfolio

However, we can take a more simplistic view by comparing the rolling 50-day standard deviation of the Russell 2000 with the S&P 500.  Russell 2000 on an absolute and relative basis does very well when rolling 50-day standard deviation of the Russell 2000 minus the same standard deviation on the S&P 500 exceeds –1.25%, so the Russell 2000 performs best when volatility approaches the S&P 500.  In low relative volatility environments, it seems we should own the high beta Russell 2000.  You will see the largest down moves all occur in the non-shaded time periods.

From TimelyPortfolio

I intentionally wanted this post to be simple, so I hid a lot of the preliminary work and extra links.  Far more went into this than appears above.

R code from GIST:

5 comments:

  1. Nice. Interesting insight. Thanks.

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  2. Very interesting. Wonder how long it will continue.

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  3. Thanks for the excellent work. COuld you explain how you calculate this in more detail? Do you substract the 50 day standard deviation of the $SPX from the 50 day Std. Dev of the $RUT? or do you do some ratio? Thanks.

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  4. Very interesting - it seems as though this could be a new method to identify high and low risk regimes by vol differentials (and not by absolute vol)!

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  5. As I started to generalize through testing on French data, I realized there are some potential issues with this methodology as the dataset gets long and relative strength moves persist, such as growth versus value since 1926. I found a paper that addresses some of this. I'll try to dig up the link to post in a comment soon, so readers can test and extend.

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