Regarding volatility forecasting specifically, I would note that VAR is based on a volatility forecast. If it were really that simple to do, Long Term Capital Management probably wouldn’t have hit the ground at terminal velocity, nor would JP Morgan have blown away a few billion dollars.

Traditional asset allocation requires returns, standard deviations, and correlations. All of these change over time, but returns change the most–and mean variance optimization is most sensitive to returns.

I’m looking forward with optimism to your forthcoming paper researching the relative forecastability of those factors. It could be a big contribution to the literature.

Thanks for your thoughtful reply.

At root, I guess I’m surprised by your belief that returns can be forecast (via momentum), but volatility and correlation forecasts are elusive.

We just published an article on Adaptive Asset Allocation which demonstrates the effectiveness of integrating return (momentum), volatility and correlation forecasts across 10 major global asset classes into an integrated portfolio management framework. By the way, we used very standard parameters for the article – there are _much_ better ways to estimate volatility and correlation than 60 or 120 day rolling averages, and which don’t use complex algos like GARCH.

We are currently working on a piece that researches the relative ‘forecastability’ of each of the parameters – I will send it along to you. However, Eric Falkenstein did some interesting preliminary analysis at his site a while back on volatility forecasting:

http://falkenblog.blogspot.ca/2012/02/market-timing-rule-that-works.html

This and other research I’ve seen suggests that volatility may be more easily forecast than returns (though momentum based return forecasts are not dealt with in Falkenstein’s short article).

Lots to think about, and thanks again for all your excellent work.

This is another way to assess how RS is doing versus the market. We post this on a regular basis. The long-term trend is steadily up, but there are periods where the spread moves down or is choppy. We’ve had a lot more of that lately.

Joe,
I’ve included a link to an earlier post that describes one of the ways to assess how the market and the strategy are interacting. We usually update our data annually. The current paper can be found at http://www.dorseywrightmm.com on the resources tab.