Volatility premium

Implied Volatility Indexes for European Government Bond Markets

28.October 2020

Volatility indexes are essential parts of the financial markets. They offer investable opportunities and exposure to the volatility, but most importantly, those indexes offer forward-looking measures of option-implied uncertainty. Therefore, such indexes are often used as indicators of risk or sentiment in the markets. For example, the well-known VIX index is often called the fear-index. The volatility indexes are not exclusive to the equity market. There are fixed-income option-implied volatility indexes for US Treasury futures, but the European fixed income market lacks such index. This novel research paper by Jaroslav Baran and Jan Voříšek fills this gap and proposes volatility indexes, connected to the euro bond futures using the Cboe TYVIX (US Treasury implied volatility index) (2018) methodology. As a result, the TYVIX and euro bond futures volatility indexes are directly comparable.

Authors: Jaroslav Baran and Jan Voříšek

Title: Volatility indices and implied uncertainty measures of European government bond futures

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Cryptocurrency Volatility Index

23.July 2020

Whenever traders want to assess the stock market’s mood, there is one really popular and useful index the most of them turn to. Yes, you guessed it right, it’s CBOE’s VIX Index. And which index can we use if we want to determine the mood of the cryptocurrencies? We can turn to a paper written by Fabian Woebbeking, which offers the methodology to compute two cryptocurrency volatility indexes (CVX & CVX76). The CVX and CVX76 Indexes also extract the market’s expectation of future volatility from option prices, but from options on the Bitcoin. The research suggests that the cryptocurrency option market has finally reached a sufficient market size to extract stable cryptocurrency volatility information.

Authors: Fabian Woebbeking

Title: Cryptocurrency Volatility Markets

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Why Do Top Hedge Funds Outperform?

30.January 2020

Every hedge fund manager and every trader wants to know what strategies are employed in a fund ran by his competition. The curiosity is even stronger if we want to see how strategies are mixed in the kitchen of the most successful hedge funds. Top performing funds are usually notoriously secretive about their portfolios. But we still can learn something from the history of their monthly returns. One such interesting methodology is described in a research paper written by Canepa, Gonzalez, and Skinner. Their analysis hints that the top-performing hedge funds are usually successful because they are able to manage their factor exposure better. They are not dependent so much on classical equity risk factors as average funds are. And if they are exposed to some risk factor, the top-performing hedge funds are able to close underperforming factor strategy sooner than average funds.

Authors: Canepa, Gonzales, Skinner

Title: Hedge Fund Strategies: A non-Parametric Analysis

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Quantitative Easing Increases Connectedness of Equities and Commodities

25.November 2019

Quantitative Easing policy in the US triggered a massive inflow of liquidity to financial markets. This liquidity, combined with the growing popularity of commodities as an asset class, is a cause for a higher inter-connectedness among equity and commodities markets. A recent academic study written by  Ordu-Akkaya and Soytas shows that commodities are not such a good diversifier as they used to be in the past. Moreover, commodity markets are also affected, as periods of higher equity volatility impact commodities significantly more …

Authors: Ordu-Akkaya, Soytas

Title: Unconventional Monetary Policy and Financialization of Commodities

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FOMC Equity Drift Occurs in Periods of High Uncertainty

27.December 2018

A new research paper related mainly to:

#75 – Federal Open Market Committee Meeting Effect in Stocks

Authors: Martello, Ribeiro

Title: Pre-FOMC Announcement Relief

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3286745

Abstract:

We show that the pre-FOMC announcement drift in equity returns occurs mostly in periods of high market uncertainty or risk premium. Specifically, this abnormal return is explained by a significant reduction in the risk premium (implied volatility and variance risk premium) prior to the announcement, but only when the risk premium is high, e.g., when it is above its median. Likewise, the magnitude of the FOMC Cycle and other related patterns varies with uncertainty and risk premium. Market uncertainty measures are persistent and are not related to policy uncertainty or expectations. Markets become only marginally stressed in the days prior to the announcement and changes in uncertainty appear to be of lower frequency. We also explain why recent studies suggest that the pre-FOMC drift might have disappeared in the past decade, as this moderation is due to time variation that was also present in older data. Additionally, CAPM only works on FOMC dates when the risk premium is high, e.g., implied vol above its prior median level. The results are robust to different samples and measures of risk premium and uncertainty.

Notable quotations from the academic research paper:

"We show that pre-announcement return drift is associated with significant declines in risk (premium) during times of high risk (premium). Implied volatility and the variance risk premium decrease in the hours before the announcement in an almost perfect mirror image of the increase in market prices. Moreover, we show that the magnitude of the return drift and the decline in risk depends on the level of market implied volatility, or other related variables, days or even weeks prior to the announcement.

Just to exemplify, the average pre-FOMC drift when implied volatility is above its prior median is 109 basis points (bps), while it is only 9.7 bps when it is below its median. In the bottom 20% of implied volatilities, the drift is close to zero or even negative, depending on the specification. Lucca and Moench [2015] also showed the importance of the VIX in their analysis, but here we show that this and other market uncertainty variables are actually essential for a better understanding of the pre-announcement return drift and all FOMC announcement related patterns. Figure 2 replicates a figure in Lucca and Moench [2015] that shows stock market performance around FOMC releases. Here we show that the pre-announcement drift is much stronger in periods of high risk premium and uncertainty.

We also provide clear evidence of investor relief, i.e., a decline in implied volatility or other risk measures, hours before the announcement using intraday information. Panel B of Figure 2 also shows that uncertainty is going down as a mirror image of the realized return. The magnitude of this pre-announcement investor relief also depends on the level of market uncertainty, as it tends to go down more when it is high. Considering the squared value of the VIX as our priced risk proxy, we show that, during high volatility periods, implied variance declines by 103.5 bps in anticipation of the announcement, while during low volatility periods, it rises by insignificant 0.3 bps. Hence, high volatility periods present both higher realized equity returns and greater resolution of market uncertainty hours before pre-scheduled announcements.

FOMC return patterns"


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