Volatility Exposure for Strategic Asset Allocation

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Volatility Exposure for Strategic Asset Allocation

Author Info

Marie Brière () (Centre Emile Bernheim, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussel and Credit Agricole Asset Management SGR, Paris.)
Alexandre Burgues () (Credit Agricole Asset Management SGR, Paris.)
Ombretta Signori () (Credit Agricole Asset Management SGR, Paris.)

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Abstract

This paper examines the advantages of incorporating strategic exposure to equity volatility into the investment-opportunity set of a long-term equity investor. We consider two standard volatility investments: implied volatility and volatility risk premium strategies. To calibrate and assess the risk/return profile of the portfolio, we present an analytical framework offering pragmatic solutions for long-term investors seeking exposure to volatility. The benefit of volatility exposure for a conventional portfolio is shown through a mean / modified Value-at-Risk portfolio optimization. Pure volatility investment makes it possible to partially hedge downside equity risk, thus reducing the risk profile of the portfolio. Investing in the volatility risk premium substantially increases returns for a given level of risk. A well calibrated combination of the two strategies enhances the absolute and risk-adjusted returns of the portfolio.

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Publisher Info
Paper provided by Université Libre de Bruxelles, Solvay Brussels School of Economics and Management, Centre Emile Bernheim (CEB) in its series Working Papers CEB with number 08-034.RS.

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Length: 34 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:sol:wpaper:08-034

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

This paper has been announced in the following NEP Reports:

NEP-ALL-2008-11-25 (All new papers)
NEP-FMK-2008-11-25 (Financial Markets)
NEP-RMG-2008-11-25 (Risk Management)

References listed on IDEAS
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Reinhold Hafner & Martin Wallmeier, 2007. "Volatility as an Asset Class: European Evidence," European Journal of Finance, Taylor and Francis Journals, vol. 13(7), pages 621-644. [Downloadable!] (restricted)
Eric Jondeau & Michael Rockinger, 2006. "Optimal Portfolio Allocation under Higher Moments," European Financial Management, Blackwell Publishing Ltd, vol. 12(1), pages 29-55. [Downloadable!] (restricted)
Eric Jondeau & Michael Rockinger, 2006. "The Economic Value of Distributional Timing," Swiss Finance Institute Research Paper Series 06-35, Swiss Finance Institute. [Downloadable!]
Chunhachinda, Pornchai & Dandapani, Krishnan & Hamid, Shahid & Prakash, Arun J., 1997. "Portfolio selection and skewness: Evidence from international stock markets," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 143-167, February. [Downloadable!] (restricted)
Nicolas P. B. Bollen & Robert E. Whaley, 2004. "Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?," Journal of Finance, American Finance Association, vol. 59(2), pages 711-753, 04. [Downloadable!] (restricted)
Massimo Guidolin & Allan Timmerman, 2005. "Optimal portfolio choice under regime switching, skew and kurtosis preferences," Working Papers 2005-006, Federal Reserve Bank of St. Louis. [Downloadable!]
Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(1), pages 63-98. [Downloadable!] (restricted)

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