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« Are Buybacks Ever Good for Investors? | Main | A Few More Comments on Buyback »

December 18, 2007

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Comments

Zach

Interesting to think of volatility as an asset class in and of itself. One could essentially be diversified even within this asset class trading volatility on commodities, interest rates, forex, equities, real estate, country or sector specific indices, the list goes on.

So would a good volatility manager have to be aware of volatility trends and histories in all other asset classes?

this is fun to mentally unpack.

ZeroBeta

Zach,

Thanks for the post. It is very interesting, but it is not really a deep market. While a hedge fund or other institutional investor could enter into a swap agreement on various types of volatility, the most liquid market is the VIX which is based on the S&P 500. My guess is Goldman will offer (probably already does) structured products based on some type of volatility measure on some major index, most likely the VIX.

I would think they would use volatility as an overlay, whereas they allocate a percentage of the portfolio to beta - the market, and allocate other portions to some uncorrelated strategies - such as Volatility, long/short pair trades, commodities, currencies, etc. You must be aware that when you are short volatility, you are sitting on very fat tail risk - small probability large losses ("picking up nickels in front of a steamroller") and positions can get risker as time goes on.

A good volatility manager, I guess would be aware of trends and histories, but I would think that he would have to be most aware of the risk he is sitting at at all times. These positions can change quickly, so he needs to make sure he has his risks well defined and hedged.

The only problem that I have is that volatility is the path an asset class takes to get to some desination. The markets are not like the straight path you take in say a treasury bill. It is a treacherous path that twists and turns. Trying to hedge your market risk is akin to taking the shortcut. It may work well 99 times out of a hundred, but one time you will end up trespassing in some guys backyard and find yourself staring down the barrel of a shotgun.

Best,

ZB

registered investment advisor

In my opinion, it is just another dangerous invention by Wall Street to pick your pocket.

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