Alpha Generation and Risk Smoothing using Managed Volatility Reply

Author(s): Tony Cooper

Date: August 6, 2010

Abstract: It is difficult to predict stock market returns but relatively easy to predict market volatility. But volatility predictions don’’t easily translate into return predictions since the two are largely uncorrelated. We put forward a framework that produces a formula in which returns become a function of volatility and therefore become somewhat more predictable. We show that this strategy produces excess returns giving us the upside of leverage without the downside.

As a side-effect the strategy also smoothes out volatility variation over time, reduces the kurtosis of daily returns, reduces maximum drawdown, and gives us a dynamic timing signal for tilting asset allocations between conservative and aggressive assets. It has been said that diversi…cation is the only free lunch in investing. It appears that once you have diversi…ed away some risk you can get a further free lunch by smoothing what risk remains.

Text: AlphaGenerationAndRiskSmoothingUsingManagedVolatility

Asymmetric Volatility Risk: Evidence from Option Markets Reply

Author(s): Jens Jackwerth, Grigory Vilkov

Date: September 23, 2013

AbstractUsing non-parametric methods to model the dependencies between risk-neutral distributions of the market index (S&P 500) and its expected volatility (VIX), we show how to extract the expected risk-neutral correlation between the index and its future expected volatility. Comparing the implied correlation to its realized counterpart reveals a significant risk premium priced into the index-volatility correlation, which can be interpreted as the compensation for the fear of rising volatility during and after a market crash, i.e., fear of crash continuation for a prolonged period of time. We show how the index-volatility correlation premium is related to future market returns and explain its economics.

Text: AsymmetricVolatilityRiskEvidenceFromOptionMarkets