This post was originally published in LinkedIn pulse on July 17, 2016
As I write, the extreme volatility in financial markets continued in year 2016 with no prospects of abating in the future. It is becoming customary to blame the volatility as a reason for excessive risk-aversion and poor investment performance. Yet, if you have the right mindset and strategies to benefit from these swings, you may actually welcome these type of volatile markets. There is indeed evidence that quant funds outperformed their peers in 2016 (see bloomberg article)
During past years I have found the great value in using implied and realized volatilities for volatility trading and quantitative investment strategies (see my past post). The ability to stay focused and to follow quantitative models for investment decisions is what sets you apart in these volatile markets and contributes to your performance. The implied volatility from option prices typically overestimates the magnitude of extreme events across all assets – see the figure above (you can find more details in my presentation). The volatility risk-premium can indeed be earned using a quantitative model.
Nevertheless, after many years of working on volatility models, I realize that there a lot of gaps and inconsistencies in existing models for measuring and trading volatility. Unsurprisingly, by designing a model that sets you apart from the existing ones, you can significantly improve the performance of your investment strategies.
In workshop presentation at Global Derivatives Conference 2016 I have discussed in depth the volatility risk premia. The beginning and largest part of the presentation is devoted to measuring and estimating historical volatilities. The historical volatility is the key to many of the quantitative strategies, so that the historical volatility an important starting point in all applications. Then I discuss delta-hedging, transaction costs, and macro-risk management. Finally, I discuss using volatility for systematic investment strategies.
Artur Sepp works as a Quantitative Strategist at the Swiss wealth management company Julius Baer in Zurich. His focus is on quantitative models for systematic trading strategies, risk-based asset allocation, and volatility trading. Prior to that, Artur worked as a front office quant in equity and credit at Bank of America, Merrill Lynch and Bear Stearns in New York and London with emphasis on volatility modelling and multi- and cross-asset derivatives valuation, trading and risk-managing. His research area and expertise are on econometric data analysis, machine learning, and computational methods with their applications for quantitative trading strategies, asset allocation and wealth management. Artur has a PhD in Statistics focused on stopping time problems of jump-diffusion processes, an MSc in Industrial Engineering from Northwestern University in Chicago, and a BA in Mathematical Economics. Artur has published several research articles on quantitative finance in leading journals and he is known for his contributions to stochastic volatility and credit risk modelling. He is a member of the editorial board of the Journal of Computational Finance. Artur keeps a regular blog on quant finance and trading at http://www.artursepp.com.
The views and analysis presented in this article are those of the author alone and do not represent any of the views of his employer. This article does not constitute an investment advice.