Exercise

Volatility targeting in tactical asset allocation

GARCH volatility predictions are of direct practical use in portfolio allocation. According to the two-fund separation theorem of James Tobin, you should invest a proportion \(w\) of your wealth in a risky portfolio and the remainder in a risk free asset, like a US Treasury bill.

When you target a portfolio with 5% annualized volatility, and the annualized volatility of the risky asset is \(\sigma_t\), then you should invest \(0.05/\sigma_t\) in the risky asset.

Instructions 1/4

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Compute the daily and annualized volatility.

Take Hint (-7 XP)