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Buy rough, sell smooth

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  • Paul Glasserman
  • Pu He

Abstract

Recent work has documented roughness in the time series of stock market volatility and investigated its implications for option pricing. We study a strategy for trading stocks based on measures of their implied and realized roughness. A strategy that goes long the roughest-volatility stocks and short the smoothest-volatility stocks earns statistically significant excess annual returns of 6% or more, depending on the time period and strategy details. The profitability of the strategy is not explained by standard factors. We compare alternative measures of roughness in volatility and find that the profitability of the strategy is greater when we sort stocks based on implied rather than realized roughness. We interpret the profitability of the strategy as compensation for near-term idiosyncratic event risk.

Suggested Citation

  • Paul Glasserman & Pu He, 2020. "Buy rough, sell smooth," Quantitative Finance, Taylor & Francis Journals, vol. 20(3), pages 363-378, March.
    • Handle: RePEc:taf:quantf:v:20:y:2020:i:3:p:363-378
    DOI: 10.1080/14697688.2019.1675899
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    Cited by:

    1. Han, Bingyan & Wong, Hoi Ying, 2021. "Merton’s portfolio problem under Volterra Heston model," Finance Research Letters, Elsevier, vol. 39(C).
    2. Li, Chenxing, 2022. "A multivariate GARCH model with an infinite hidden Markov mixture," MPRA Paper 112792, University Library of Munich, Germany.
    3. Eduardo Abi Jaber & Enzo Miller & Huyên Pham, 2020. "Markowitz portfolio selection for multivariate affine and quadratic Volterra models," Working Papers hal-02877569, HAL.
    4. Eduardo Abi Jaber & Enzo Miller & Huyên Pham, 2021. "Markowitz portfolio selection for multivariate affine and quadratic Volterra models," Post-Print hal-02877569, HAL.
    5. Eduardo Abi Jaber & Enzo Miller & Huy^en Pham, 2020. "Markowitz portfolio selection for multivariate affine and quadratic Volterra models," Papers 2006.13539, arXiv.org, revised Jan 2021.
    6. Eduardo Abi Jaber & Enzo Miller & Huyên Pham, 2021. "Markowitz portfolio selection for multivariate affine and quadratic Volterra models," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-02877569, HAL.

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