Hi to everybody,

Rebalancing implies being short volatility. Why? Just because we get rid of existing positions and then cut volatility on those opened positions?

Thank you

Hi to everybody,

Rebalancing implies being short volatility. Why? Just because we get rid of existing positions and then cut volatility on those opened positions?

Thank you

Itâ€™s not quite as simple as they make it sound.

First, they need to define what they mean by â€śvolatilityâ€ť. Volatility of returns? (Probably not.) Volatility of prices? (Probably so.)

Assuming that they mean volatility of prices, and assuming that prices are increasing, then by rebalancing (returning to the initial target weights), you would sell securities with large price changes (selling high volatility) and buy securities with small price changes (buy low volatility). The net is a decrease in volatility.

Of course, if prices are decreasing, then rebalancing increases your volatility.

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Thank you (again ) for this answer.

In fact I read that in the summary of the reading Â« principles of asset allocation Â» but couldnâ€™t find the concept elsewhere in the curriculum. Here is the short paragraph relating to my question:

Â« * Disciplined rebalancing has tended to reduce risk while incrementally adding to returns. Interpretations of this empirical finding include that rebalancing earns a diversification return, that rebalancing earns a return from being short volatility, and that rebalancing earns a return to supplying liquidity to the market. Â»

Interpretations = guesses.

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could you please help me understand this paragraph as well? i canâ€™t even prove the first part mathematically/ thank a lot!!!

Rebalancing earns a diversification return. The compound growth rate of a portfolio is greater than the weighted average compound growth rates of the component portfolio holdings (given positive expected returns and positive asset weights). Given sufficiently low transaction costs, this effect leads to what has been called a diversification return to frequent rebalancing to a well-diversified portfolio.44

Sounds like fantasy to me.

Assuming that by rebalancing they mean returning the portfolio to its original weights, then youâ€™re taking money out of securities that are growing faster and putting it into securities that are growing slower. Thatâ€™s a loss, not a gain.

Short put option when current weight is below target. Short call option when it is above target.