Volatility Weighting Over Time in the Presence of Transaction Costs

Numerous empirical studies demonstrate the superiority of dynamic strategies with volatility weighting over time mechanism. These strategies control the portfolio risk over time by adjusting the risk exposure according to updated volatility forecasts. Yet, in order to reap all benefits promised by volatility weighting over time, the composition of the active portfolio must be revised rather frequently. Transaction costs represent a serious obstacle to benefiting from this dynamic risk control technique. In this paper we propose a modified volatility weighting strategy that allows one to reduce dramatically the amount of trading costs. The empirical evidence shows that the advantages of the modified volatility weighting strategy persist even in the presence of high transaction costs