How is the volatility-adjusted return calculated?

The volatility-adjusted return is calculated by taking the ratio of the new volatility estimate to the old volatility estimate and then multiplying it by the actual return. This approach recognizes that changes in volatility affect the risk of the investment, and hence the expected returns need to be adjusted accordingly.

When volatility increases, it typically indicates higher risk, which can lead to adjustments in the required return to compensate for this increased risk. By using the ratio of new to old volatility, you are effectively scaling the actual return by how much the risk has changed. If the new volatility is higher than the old, the actual return will be scaled down to reflect this increased risk. Conversely, if the new volatility is lower, the return will be scaled up.

This calculated volatility-adjusted return provides a more accurate measure of performance by accounting for the risk inherent in the investment, ensuring that returns are comparable across different volatility environments.