Decomposing Cross-Sectional Volatility (September 2010)

Abstract

Cross-sectional volatility is given by the standard deviation of a set of asset returns over a single time period. CSV is critical because it represents the opportunity to outperform a benchmark. In this Research Insight, we present an exact methodology for decomposing CSV into contributions from individual factors. Our approach treats countries, industries, and style factors on an equal basis. We employ our framework to investigate several relevant questions in the global equity markets, such as the importance of industries versus countries, emerging markets versus developed markets, or the strength of style factors relative to industries or countries. We also extend our methodology to decompose and analyze the root mean squared (RMS) return, which is of greater relevance to absolute return managers.

Keywords: Cross-sectional volatility asset returns over a single time period outperform benchmark decomposing methodology CVS contributinos individual factors global equity markets New Risk Modeling Methods