BNP Paribas’ QIS Lab’s latest research guides the reader through the latest findings in volatility-arbitrage strategies in portfolio risk management.
Key research content takeaways:
◼ The report shows how to select strikes, expiries and how to combine options to capture the volatility-risk premium.
◼ Important risk-management issues – computing hedge ratios, adjusting exposure and allocating across strategies – are also addressed.
◼ Tail risk and geopolitical risk are key drivers of the volatility-risk premium. Various models are proposed to identify value across markets and instruments.
◼ The report introduces a flagship, multi-asset portfolio of volatility-arbitrage strategies designed to capture the risk premium consistently over time.
BNP Paribas’ QIS Lab has released its latest whitepaper ‘Every Vol, Everywhere, All At once’ which is focused on the latest research in volatility-arbitrage strategies in portfolio risk management.
This moves the conversation on from the lab’s previous publications such as ‘equity dispersion – how, what and when to trade’ and dives into significant empirical and theoretical material covering this core offering from the Bank.
Volatility arbitrage plays a central role in many investment strategies – either as an overlay to a portfolio, as a liquid, alternative investment or as a way of mitigating the cost of carry in a hedging position. The document provides a comprehensive overview of volatility arbitrage, including its statistical properties, trading strategies, and risk management techniques.
With a variety of markets, options and trading choices, an investor who wishes to harvest the volatility-risk premium is faced with two important questions – ‘Which markets should be chosen?’ and ‘How should the design of the volatility-arbitrage programme be specified?’
Providing an overview of how to build an efficient volatility‑arbitrage strategies and to select the appropriate markets and techniques for a multi‑asset volatility‑risk‑premium portfolio, the report also provides some novel quantitative research on the pricing of volatility risk.
Research findings for volatility-arbitrage strategies in portfolio risk management
The variance-risk premium across markets
This report opens with the concept of the variance-risk premium and its statistical properties across different asset classes, including equities, commodities, currencies, rates, and credit. The authors analyse the term structure of the variance-risk premium and its relationship with market volatility.
How to become a volatility arbitrageur
A briefing on how to trade volatility arbitrage, including the design choices and empirical findings. It shows how to capture the premium through single options or variance-replicating baskets, and explores the technical issues involved in single-option arbitrage.
Decoding equity volatility-arbitrage strategies
The authors discuss the practical issues involved in selling and hedging options on equity indices and very short-dated expiries, which now play a major role in the options market, are also examined.
A behavioural theory of volatility arbitrage
The research explores the link between tail risk and volatility arbitrage by drawing on behavioural finance and extreme-value theory and how this is then used to select the most attractive volatility-arbitrage strategies.
(Almost) every vol, everywhere…
This chapter introduces a multi-asset portfolio of volatility-arbitrage strategies, the rationale for selecting these strategies and provides an overview of the portfolio’s performance.
… all at once – managing risk
The report concludes with comparing the best risk models for allocating across strategies and how to optimise investment portfolios.
For more information on volatility-arbitrage strategies, to request the full paper, or to discuss how our findings could boost your portfolio, please get in touch with Julien Turc or Raphael Dando.
If you are a BNPP client with access to Brio you can access the report here.