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Volatility Managed Short Duration Premium

Bressand, Julie Marie Tangerås; Rostrup, Thea Elise Solheim
Master thesis
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URI
https://hdl.handle.net/11250/3015932
Date
2022
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  • Master Thesis [4657]
Abstract
This thesis investigates if the short duration premium of the equity duration strategy can be

improved by managing its volatility. Based on estimates by Gonçalves (2021), we replicate

equity duration sorted portfolios of U.S. stocks from 1973 to 2019, and identify a 9.3%

premium for a strategy buying short duration firms, and selling long duration firms. These

findings support literature suggesting the existence of a downward-sloping equity term

structure. Managing the volatility of the equity duration strategy results in a reduction of 4.2%

annualized risk-adjusted return, suggesting that volatility management does not lead to an

improvement of the short duration premium. In contrast to strategies for which volatility

management increases premiums, we note that the original equity duration strategy has a

high positive skewness of 0.64, which is completely diminished. We argue that volatility

management is not suitable for the equity duration strategy as strategy returns are generally

high in periods of high volatility, and returns are generally low in periods of low volatility. We

finalize our exploration of the short duration premium by testing its merits in a multi-factor

environment. We show that combining the equity duration strategy with traditional asset

pricing models in Markowitz’s (1952) portfolio optimization model increases Sharpe ratios

significantly. Our findings underscore the viability of the equity duration investment strategy

but warn investors of scaling investments to its volatility.

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