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Dynamic Volatility Trading Strategies in the Currency Option Market

26 Sep 2011

Article by: Dajiang Guo
Published by: Review of Derivatives Research
Date: Revised 2006

“The conditional volatility of foreign exchange rates can be predicted using GARCH models or implied volatility extracted from currency options. This paper investigates whether these predictions are economically meaningful in trading strategies that are designed only to trade volatility risk. First, this article provides new evidence on the issue of information content of implied volatility and GARCH volatility in forecasting future variance. In an artificial world without transaction costs both delta-neutral and straddle trading stratgies lead to significant positive profits, regardless of which volatility prediction method is used. Specifically, the agent using the Implied Stochastic Volatility Regression method (ISVR) earns larger profits than the agent using the GARCH method. Second, it suggests that the currency options market is informationally efficient. After accounting for transaction costs, which are assumed to equal one percent of option prices, observed profits are not significantly differentfrom zero in most trading strategies. Finally, these strategies offered returns have higher Sharpe ratio and lower correlation with several major asset classes. Consequently, hedge funds and institutional investors who are seeking alternative “marketneutral” investment methods can use volatility trading to improvethe risk-return profile of their portfolio through diversification.”

Full article: Link

 
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Posted in Implied volatility, Realized volatility

 

Time-Varying Sharpe Ratios and Market Timing

11 Sep 2011

Article by: Robert F. Whitelaw
Published by: NYU, Stern School of Business
Date: 19 Nov 1997

“This paper documents predictable time-variation in stock market Sharpe ratios. Predetermined
nancial variables are used to estimate both the conditional mean and volatility of equity returns,
and these moments are combined to estimate the conditional Sharpe ratio. In sample, estimated
conditional Sharpe ratios show substantial time-variation that coincides with the variation in ex
post Sharpe ratios and with the phases of the business cycle. Generally, Sharpe ratios are low
at the peak of the cycle and high at the trough. In out-of-sample analysis, using 10-year rolling
regressions, we can identify periods in which the ex post Sharpe ratio is approximately three times
larger than its full-sample value. Moreover, relatively naive market-timing strategies that exploit
this predictability can generate Sharpe ratios more than 70% larger than a buy-and-hold strategy.”

Full article (PDF): Link

 
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Posted in Investing ideas

 

Betting on volatility: Can you make money from fear?

22 Aug 2011

Article by: John Waggoner
Published by: USA Today
Date: Aug 2011

“When the stock market dives 300 points, pundits start talking about increased volatility. By that reasoning, a broken arm could be referred to as increased flexibility.

“Thanks to the ever-inventive exchange-traded fund industry, volatility is not just a concept: It’s an investment opportunity. Why you would want to invest in volatility is another question — particularly, since not all the current offerings track volatility that well.

“Wall Street’s main measure of volatility is the CBOE Volatility Index, known as the VIX. Some people also call it the Fear Index, because most people associate big sharp market moves with scary down moves.

“Properly speaking, however, volatility refers to both up and down movements.”

Full article: Link

 
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Posted in Implied volatility, Investing ideas

 

Trading Volatility As An Asset Class

10 Aug 2011

Article by: Emanuel Derman
Published by: Columbia University
Date: 10 Jun 2003

“Volatility is a useful trading hedge against all kinds of disasters. How can you trade it? Calls and puts don’t quite do it. Though calls and puts are sensitive to volatility, they are not sensitive only to volatility. How can you do better?”

Full article (PDF): Link

 
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Posted in Realized volatility, Trading ideas

 
 
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