On the Informational Content of Changing Risk for Dynamic Asset Allocation

The informational content of changing risk for dynmaic asset allocation is analyzed in order to investigate its importance in determining expected index returns. We consider a class of optimal dynamic strategies taking into account both changing risk and expected returns that vary accordingly to changing risk. We compare their risk adjusted performance to that of a buy and hold strategy under different hypotheses on the form of conditionally expected returns. The statistical evidence in favour of expected returns varying accordingly to changing risk is elusive. On the other hand, we find some evidence of a superior unconditional risk adjusted performance of volatility based trading rules compared to buy and hold strategies. This suggests that changing risk conveys information useful to improve performance.