Volatility Weighting is a portfolio construction technique that adjusts the allocation of assets based on their historical or implied price fluctuations. In crypto investing, this methodology assigns lower weights to more volatile assets and higher weights to less volatile ones, aiming to achieve a more stable portfolio return or a specific risk target.
Mechanism
The mechanism involves calculating the historical standard deviation or variance of each asset’s returns over a specified period, or using implied volatility derived from options markets. These volatility measures are then inversely applied as weights to each asset in the portfolio. For example, a cryptocurrency exhibiting higher historical price swings would receive a smaller allocation compared to a stablecoin or a less volatile token.
Methodology
This methodology aims to reduce overall portfolio risk by moderating exposure to assets prone to significant price movements. It often forms part of a broader risk parity or minimum variance strategy, where capital is allocated to balance the contribution of each asset’s risk to the total portfolio risk. Continuous rebalancing is essential to adapt to changing market conditions and maintain the desired risk profile within the dynamic crypto asset class.
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