A five factor approach to the low volatility anomaly : an empirical study of the Norwegian stock market

Abstract

In this thesis, we construct the Fama-French five-factor model (2015a) for the Norwegian stock market in order to examine the existence of the low volatility anomaly. We estimate risk as idiosyncratic volatility relative to the Fama-French three-factor model (1993) and total volatility defined as a stock’s standard deviation with a trailing window of 24 months. Stocks are then sorted into value- and equally weighted quintile portfolios based on both risk measurements individually. Further, the excess portfolio returns are regressed on the Fama and French five-factor model to control for the systematic risk factors; market, size, value, operating profitability and investment. This lets us examine the existence of the low volatility anomaly by looking at monthly excess returns, Sharpe (1966) ratios and alphas for each of the quintile portfolios. We are unable to prove the existence of the anomaly through excess returns alone as we find a positive, but statistically insignificant, difference in excess return between the lowest and highest quintile portfolio. However, we are able to document the anomaly through the alphas. Regardless of volatility measurement and weighting scheme, we find statistically significant positive differences in alphas between the lowest and highest quintile portfolios. Our results are robust after controlling for different measurements of idiosyncratic volatility, subsamples, filtering process and return requirements. This leads us to the conclusion that the low volatility anomaly is present in the Norwegian stock market in the period August 1993 to December 2017.