Buy Rough, Sell Smooth

34 Pages Posted: 3 Jan 2019 Last revised: 9 Jan 2019

See all articles by Paul Glasserman

Paul Glasserman

Columbia Business School

Pu He

Columbia University - Columbia Business School

Date Written: December 1, 2018

Abstract

Recent work has documented roughness in the time series of stock market volatility and investigated its implications for option pricing. We study a strategy for trading stocks based on measures of their implied and realized roughness. A strategy that goes long the roughest-volatility stocks and short the smoothest-volatility stocks earns statistically significant excess annual returns of 6% or more, depending on the time period and strategy details. The profitability of the strategy is not explained by standard factors. We compare alternative measures of roughness in volatility and find that the profitability of the strategy is greater when we sort stocks based on implied rather than realized roughness. We interpret the profitability of the strategy as compensation for near-term idiosyncratic event risk.

Keywords: fractional Brownian motion, rough volatility, asset pricing, event risk, realized kernel, option pricing, implied and realized roughness

Suggested Citation

Glasserman, Paul and He, Pu, Buy Rough, Sell Smooth (December 1, 2018). Available at SSRN: https://ssrn.com/abstract=3301669 or http://dx.doi.org/10.2139/ssrn.3301669

Paul Glasserman

Columbia Business School ( email )

3022 Broadway
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Pu He (Contact Author)

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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