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Probabilistic Forecasts of Volatility and its Risk Premia

07 Jan 2013

Article by: Worapree Maneesoonthorn, Gael M. Martin, Catherine S. Forbes and Simone Grose
Published by: Department of Econometrics and Business Statistics, Monash University
Date: 21 Feb 2012

“The object of this paper is to produce distributional forecasts of asset price volatility and its associated risk premia using a non-linear state space approach. Option and spot market information on the latent variance process is captured by using dual ‘model-free’’ variance measures to define a bivariate observation equation in the state space model. The premium for variance diffusive risk is defined as linear in the latent variance (in the usual fashion) whilst the premium for variance jump risk is specified as a conditionally deterministic dynamic process, driven by a function of past measurements. The inferential approach adopted is Bayesian, implemented via a Markov chain Monte Carlo algorithm that caters for the multiple sources of non-linearity in the model and for the bivariate measure. The method is applied to spot and option price data on the S&P500 index from 1999 to 2008, with conclusions drawn about investors required compensation for variance risk during the recent financial turmoil. The accuracy of the probabilistic forecasts of the observable variance measures is demonstrated, and compared with that of forecasts yielded by alternative methods. To illustrate the benefits of the approach, it is used to produce forecasts of prices of derivatives on volatility itself. In addition, the posterior distribution is augmented by information on daily returns to produce value at risk predictions. Linking the variance risk premia to the risk aversion parameter in a representative agent model, probabilistic forecasts of (approximate) relative risk aversion are also produced.”

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Posted in Realized volatility

 

VolContract Futures Overlay on an S&P 500 Portfolio

08 Nov 2012

Article by: Sixiang Li
Published by: The Volatility Exchange (VolX)
Date: Oct 2012

“The Volatility Exchange™ (VolX®) plans to launch futures and options contracts based upon the realized volatility of U.S. equity indices. The futures version is named VolContract™ futures (VCs), which settle to the VolX indices known generically as RVOL™. The concept is both similar and dissimilar to the popular VIX® index and products marketed by the CBOE®. The two versions are similar in the notion that both VolX and CBOE are trying to provide volatility products to the marketplace. They are dissimilar because the VIX index and consequently VIX futures are based on implied volatility (the relative cost of options) while the RVOL index and consequently VCs are based on realized volatility (the actual, historical movement of the underlying index). VolContract futures are exchange‐tradable instruments that function similarly to a forward‐starting over‐the-counter volatility swap. They are expected to be launched on U.S. equity indices in 2013 and will come in two varieties: a 1‐month calculation period of realized volatility (1Vol™) and a 3‐month calculation period of realized volatility (3Vol™). For a detailed description of how these new instruments work, please visit the web site of The Volatility Exchange at www.volx.us. The goal of this paper is to demonstrate how a VC overlay can enhance the return and/or reduce the standard deviation of an equity portfolio. We chose the S&P 500 Total Return Index on the assumption that VolX will roll out products based upon this index.”

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Practical Volatility and Correlation Modeling for Financial Market Risk Management

14 Oct 2012

Article by: Torben G. Andersen, Tim Bollerslev, Peter F. Christoffersen, Francis X. Diebold
Published by: National Bureau of Economic Research
Date: Jan 2005

“What do academics have to offer market risk management practitioners in financial institutions? Current industry practice largely follows one of two extremely restrictive approaches: historical simulation or RiskMetrics. In contrast, we favor flexible methods based on recent developments in financial econometrics, which are likely to produce more accurate assessments of market risk. Clearly, the demands of real-world risk management in financial institutions — in particular, real-time risk tracking in very high-dimensional situations — impose strict limits on model complexity. Hence we stress parsimonious models that are easily estimated, and we discuss a variety of practical approaches for high-dimensional covariance matrix modeling, along with what we see as some of the pitfalls and problems in current practice. In so doing we hope to encourage further dialog between the academic and practitioner communities, hopefully stimulating the development of improved market risk management technologies that draw on the best of both worlds.”

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Posted in Implied volatility, Realized volatility

 

Being particular about calibration

08 Oct 2012

Article by: Julien Guyon and Pierre Henry-Labordère
Published by: risk.net/risk-magazine
Date: Jan 2012

“Following previous work on the calibration of multifactor local stochastic volatility models to market smiles, Julien Guyon and Pierre Henry-Labordère show how to calibrate exactly any such model. Their approach, based on McKean’s particle method, extends to hybrid models, where interest rates are also stochastic. They illustrate the efficiency of their algorithm on hybrid local stochastic volatility models.”

Full article (PDF): Link

 
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Posted in Implied volatility

 
 
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