As a general rule, if you believe you have too much volatility in your portfolio, you need to take less risk. Taking less risk will dampen expected returns. You can hedge dynamically or at inception; you can be less concentrated in risky assets; you can diversify your risk drivers. Across multiple decades, no one has come up with a consistent way to get great returns without risk. In today's low yielding environment, this is a pervasive concern. 

If you "own" the volatility - just sell it by writing options using option strategies (call- and put-spreads, straddles, strangles,...).

Be an option trader!!!

Apart from trading options , you may wish to assign correlation between the VaR of each asset type. Then project price following linear regression.

Thanks Sergei for the great comment. One of the main issues with the real estate market or heterogeneous assets that there are very limited derivatives, such as options. Thus, the most feasible hedging is diversification in portfolio setting as Donna pointed out but investors (including professional money managers) need to be acutely aware of the time varying risk.... Why do people think things (correlations) are stable, everything is changing , so does correlation/risk.

If you have "too much" volatility, you have a serious problem, and you will likely have overestimated the value of your portfolio.

Bowman's Paradox has shown that there is an inverse relationship between risk and return, that kicks in at "high Risk" levels - which is likely the same as your "too high volatility". You need to consider, that your economic portfolio value is likely impaired, at your current risk levels.

The logic of the value loss has eluded exact description for some time, but is getting closer to being exposed.

It is likely that a major contribution to the value loss comes from a loss, that is mediated through your capital reserve. A cost or value effect on one asset, can have a negative value effect on other and unrelated assets.

So I contest, that you need introduce a financial stress test setup, which illustrates how the volatility impacts your capital reserves and your financial obligations to 3rd parties.

If the volatility

1. cannot make you run out of capital reserves and

2. cannot force you to fail in meeting your 3rd party obligations

... it is likely that you don't have too much volatility

If the volatility have certain realistic probability of causing one of the two above, you need diversify/insure/hedge very fast, because your investments value is impaired - no matter what your VaR analysis tells you.

If you have a well characterized portfolio i would advise to use Monte Carlo simulations, but alternatively scenario based stress testing can be used to assure your are robust towards relevant scenarios.

Apart from every other factor already included, basic fact remains to add a price premium to cover for the volatility of the asset while trading ( while selling) and to duly consider only bid premium while buying such asset. One can also trade in volatility alone though how one can construct a volatility asset meaningfully in a heterogenous asset class, remains a tough trick for OTC practitioners

 If there is high volatality, mean you are bearing the high risk. in order to maintain the risk at your risk tolerance level you have to adopt mixed strategy by using call and put option at the same time like straddle strategy.  Also revisit your portfolio selection method.

Dear Zsuzsa:

This is a time-honored right of any author to advertised her own work. I think you already know that the answer to this question is in your paper :) Love, as always, Peter 

I am not sure that this paper will answer your question, maybe it could give you some insight. It explains the differences between implied and realized volatility and their effect on P&L and pricing.

http://www.math.ku.dk/~rolf/Wilmott_WhichFreeLunch.pdf

 Thanks L. Spafora for the interesting paper and Markus Kreer for the insightful comments. Options may not be available for real assets (real estate to which I referred in the paper) and options may become scarce or expensive when volatility is really high:

https://wpweb2.tepper.cmu.edu/wfa/wfasecure/upload2010/2010_9.831913E+08_PA_Do_Option_Markets_Undo_Restrictions_on_Short-Sales_WFA_Submission.pdf

Of course if there is guarantee in the system things are different. 

http://faculty.chicagobooth.edu/workshops/finance/pdf/toosystemictofailwhatoptionmarkets.pdf

Dear Prof. Huszar,

                                I think the financial market especially financial accounting literature which drives much of the information for asset prices is clear on this. The relevant problem to consider is that of excess volatility over and above that explained by the standard asset pricing model like the CAPM and to ask how alternative accounting disclosures can affect this excess volatility in markets. I think that is what the paper listed does. Financial Markets I believe can price correlations unless you explicitly model incomplete markets where also in the presence of options and Black Scholes Options pricing model you can have excess volatility (Polemarchakis & Ku, Journal of Mathematical Economics (1990), Mallick (2014)) on my RG webpage) where earnings disclosures can have real welfare effects on investors. I hope this discussion is useful to you. SKM QC FEPS(D)

Hi,

You may be interested by this recent paper:

Institutional ownership and aggregate volatility risk

Journal of Empirical Finance, January 2017,Pages 20-38

Alexander Barinov

Best regards

https://www.mckinsey.com/capabilities/growth-marketing-and-sales/our-insights/defying-cost-volatility-a-strategic-pricing-response