Markets: A Rigorous Course
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M14 · Problem 8 ★★ Check

Volatility targeting

A strategy's annualised volatility is 12% in calm regimes (70% of the time) and 36% in stressed regimes (30%). Its expected return is 10% a year in both. (a) Compute the unmanaged and volatility-targeted Sharpe ratios (Proposition 14.10). (b) Now suppose instead the expected return is proportional to volatility with Sharpe 0.4 in each regime. Compute both Sharpe ratios. Which one is higher, and why?

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