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Academics and practitioners are no longer surprised by the existence of the low volatility anomaly. Many papers have been published in credible journals describing the effect and several explanations have been proposed. But most of the explanations seek to preserve the traditional relationship between risk and return that serves as the fundamental basis of modern economics.
Eric Falkenstein turns this concept on its head.
Eric wrote his thesis on the low volatility effect long before it was acceptable to talk about in polite company. Despite the size of the effect and the depth and breadth of Eric’s analysis, it violated the critical “equilibrium” theory of the day and was rejected by every journal. Eric learned some valuable lessons from this experience that listeners would do well to pay attention to.
I was most intrigued with Eric’s research into an alternative equilibrium model, rooted in aversion to relative rather than absolute wealth. If investors are more concerned with relative status rather than absolute wealth then the low volatility phenomenon is a legitimate risk factor.
Eric’s work covers far more than just low volatility investing and risk models. Our discussion branches into politics, social policy, and eventually into his new pet project – cryptocurrencies. This was an all-around incredible conversation that listeners won’t want to miss.
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