- 1The fundamental premise of the Capital Asset Pricing Model (CAPM)—higher risk equals higher reward—is empirically false in equity markets
- 2Globally, the lowest volatility decile of stocks outperforms the highest volatility decile by roughly 12% annually on a risk-adjusted basis
- 3The "Volatility Anomaly" exists because mutual fund managers are evaluated on relative benchmarks and retail investors treat speculative stocks like lottery tickets
#The Global Volatility Anomaly
Blitz and van Vliet analyzed global equity markets (US, Europe, and Japan) from 1986 to 2006. They sorted stocks into deciles based on their historical 3-year trailing volatility.
According to CAPM, the high-volatility decile should earn massive premiums over the low-volatility decile to compensate investors for the roller-coaster ride.
The empirical results showed the exact opposite: - The lowest volatility decile generated an annualized return of 10.2% with a Sharpe ratio of 0.72. - The highest volatility decile generated an annualized return of 5.3% with a Sharpe ratio of 0.16.
Not only did low-volatility stocks experience less drawdown and risk, but they also generated higher absolute returns.
#Why Is Risk Unrewarded?
1. The Lottery Ticket Effect Retail investors are notoriously bad at probability. They inherently overpay for assets with massive, positive skewness—the tiny chance of a 10,000% return. Just as people buy negative-EV lottery tickets, retail investors continually over-bid highly volatile, speculative stocks.
2. The Benchmark Constraint Institutional portfolio managers are evaluated against benchmarks and are legally constrained from using leverage. If an active manager wants to outperform their benchmark in a bull market without leverage, they buy high-beta, high-volatility stocks. This massive institutional demand systematically overprices the high-volatility decile.
#Implementation in Modern Quant Systems
Following the publication of this paper, low volatility was codified as a premier academic factor. Today, Smart Beta ETFs and institutional quant platforms utilize Low Volatility as a core stabilizing mechanism to filter against speculative manias.
Last updated: April 1, 2026