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Volatility as an Asset Class for Long-Term Investors

  • Burgues, Alexander
  • Signori, Ombretta
  • Brière, Marie

This work shows how long-term investors can benefit from adding volatility as an asset class to their portfolio. Two types of "structural" exposure – long implied volatility and long volatility risk premium – are now simple to implement. Implied volatility exposure can be used to significantly reduce the risk profile of the portfolio, and especially extreme risks. Adding a volatility risk premium investment is less appealing : it substantially increases returns for a given level of risk, but at the cost of higher extreme risks. However a combination of the two volatility strategies is very attractive, thanks to fairly effective reciprocal hedging during periods of market stress. It delivers enhanced absolute and risk-adjusted returns, with smaller extreme risks than a traditional portfolio. Over the long term, volatility strategies make it possible to build portfolios that are more efficient than a pure-bond or equity/bond investment.

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File URL: http://basepub.dauphine.fr/xmlui/bitstream/123456789/9293/1/volatilitybriere.PDF
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Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/9293.

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Date of creation: 2009
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Publication status: Published in Interest Rate Models, Asset Allocation and Quantitative Techniques for Central Banks and Sovereign Wealth Funds, . pp. 265-280.Length: 15 pages
Handle: RePEc:dau:papers:123456789/9293
Contact details of provider: Web page: http://www.dauphine.fr/en/welcome.html

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  1. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. " On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December.
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  4. Christie, Andrew A., 1982. "The stochastic behavior of common stock variances : Value, leverage and interest rate effects," Journal of Financial Economics, Elsevier, vol. 10(4), pages 407-432, December.
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  6. Gurdip Bakshi & Nikunj Kapadia, 2003. "Delta-Hedged Gains and the Negative Market Volatility Risk Premium," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 527-566.
  7. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  8. Wu, Guojun, 2001. "The Determinants of Asymmetric Volatility," Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 837-59.
  9. Chang-Jin Kim & James C. Morley & Charles Nelson, 2000. "Is There a Positive Relationship between Stock Market Volatility and the Equity Premium?," Working Papers 0023, University of Washington, Department of Economics.
  10. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 63-98.
  11. P. Carr & D. Madan, 2001. "Optimal positioning in derivative securities," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 19-37.
  12. Liu, Jun & Pan, Jun, 2003. "Dynamic derivative strategies," Journal of Financial Economics, Elsevier, vol. 69(3), pages 401-430, September.
  13. Bekaert, Geert & Wu, Guojun, 2000. "Asymmetric Volatility and Risk in Equity Markets," Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 1-42.
  14. Haugen, Robert A & Talmor, Eli & Torous, Walter N, 1991. " The Effect of Volatility Changes on the Level of Stock Prices and Subsequent Expected Returns," Journal of Finance, American Finance Association, vol. 46(3), pages 985-1007, July.
  15. 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.
  16. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  17. Peter Carr & Liuren Wu, 2009. "Variance Risk Premiums," Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1311-1341, March.
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