Combining low-volatility and mean-reversion anomalies: Better together?

Article type: Research Article

Authors: Pätäri, Eero^{a; *} | Ahmed, Sheraz^a | Lankinen, Tuomas^a | Yeomans, Julian Scott^b

Affiliations: [a] LUT Business School, LUT University, Lappeenranta, Finland | [b] Schulich School of Business, York University, Toronto, ON, Canada

Correspondence: [*] Corresponding author: Eero Pätäri, LUT Business School, LUT University, P.O. Box 20, FIN-53851 Lappeenranta, Finland. Tel.: +358 40 833 6907; E-mail: eero.patari@lut.fi.

Abstract: This paper contributes to the existing stock market anomaly literature by being the first to analyze the benefits of combining two distinct anomalies; specifically, the low-volatility and mean-reversion anomalies. Our results show that on a long-only basis, these two time-varying anomalies could be combined into a double-sort investment strategy that includes some desirable characteristics from each of them, thereby making the portfolio return accumulation more stable over time. As the added-value of low-volatility investing stems mostly from the risk-reduction side, while contrarian stocks are generally highly volatile with remarkable upside potential, the use of the double-sort portfolio-formation in which the contrarian stocks are picked from the sub-set of below-median volatility stocks can shorten the below-market performance periods that have occasionally materialized for plain low-volatility or plain contrarian investors.

Keywords: Volatility, contrarian, mean reversion, anomaly, portfolio performance, equity investing

DOI: 10.3233/AF-220441

Journal: Algorithmic Finance, vol. Pre-press, no. Pre-press, pp. 1-24, 2023