On the Relevance of Variances and Correlations for Multifactor Investors
Year: 2025
Type: article
Abstract: Investors believing in diversification across multiple orthogonal risk factors should prioritize factor variances over correlations when evaluating conditional portfolio risk. This study decomposes the variance of an equally-weighted multi-factor portfolio into two components, average variance (AV) across and average correlation (AC) between factors, and shows that only AV predicts future multi-factor risk and return over the short run, therefore supporting the idea of short-term persistence in risk and a variance-in-mean relationship uncovered only when focusing on AV. The results show robustness in various instances and caution investors to bet on a dysfunctional variance-in-mean relationship by forming a volatility-managed multi-factor portfolio.
Author: Tom Oskar Karl Zeissler
Institution: Vienna University of Economics and Business
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W4416912765