Two reasons why I think reducing exposure during market volatility is a good idea.
First, volatility is predictable. (I don’t think this fact violates the EMH, so it should be uncontroversial.) Future volatility is highly correlated with recent volatility.
Second, the Kelly strategy is optimal. More exposure only helps to a point, and after that increasing leverage actually reduces gains. The right amount depends on the future payoff distribution and the size of the current bankroll.
Given those two points, Kelly implies that if your bankroll just shrunk due to a losing bet, the previous amount of exposure you calculated is now too high, and you would need reduce your exposure to maintain the target fraction even if the payoff distribution didn’t change. But we also know that the variance of the future payoff distribution is higher than what we calculated before, because volatility is somewhat predictable, and it just got higher, which suggests that you should reduce exposure even further.
Two reasons why I think reducing exposure during market volatility is a good idea.
First, volatility is predictable. (I don’t think this fact violates the EMH, so it should be uncontroversial.) Future volatility is highly correlated with recent volatility.
Second, the Kelly strategy is optimal. More exposure only helps to a point, and after that increasing leverage actually reduces gains. The right amount depends on the future payoff distribution and the size of the current bankroll.
Given those two points, Kelly implies that if your bankroll just shrunk due to a losing bet, the previous amount of exposure you calculated is now too high, and you would need reduce your exposure to maintain the target fraction even if the payoff distribution didn’t change. But we also know that the variance of the future payoff distribution is higher than what we calculated before, because volatility is somewhat predictable, and it just got higher, which suggests that you should reduce exposure even further.