Buy Local: Creation of a Robust Long-Term Single-Market Equity Strategy via COVES (Country-Oriented Volatility-Enhanced Strategies)
18 Pages Posted: 31 Aug 2021
Date Written: August 15, 2021
The home country bias for investors remains ubiquitous, despite innumerable warnings of over-investment in the investor’s domestic market. While we’ve provided potential mitigations for this phenomenon in the past, this time we focused on providing a intra-market solution that would hedge against the riskier aspects of domestic over-investment. Through the use of simple signal-based switches, we were able to provide a robust strategy that plays off the anti-correlation between the market and its volatility. Initially tested in the US market via SPY and VIX, we tested our strategy with a synthetic volatility index derived from SPY pricing data. The synthetic volatility index performed similarly to VIX, with the same broad results across both variations. These market and synthetic volatility index derivative strategies were applied to ETFs of 45 countries and resulted in improvements over the base market in practically every instance. These Country-Oriented Volatility-Enhanced Strategies (COVES) provide a powerful proof-of-concept on a volatility-based hedge for a standard market index. Unfortunately, since the volatility aspect of the COVES isn’t directly investable, these strategies are not currently viable. However, a recent advancement in Decentralized Finance known as synthetic tokens could provide the vehicle to make COVES a tangible investment product. Furthermore, additional advancements in DeFi could supplement a country-focused strategy with an inflation-hedged base currency, providing an even more powerful preservation of wealth while holding a long-term investment asset such as COVES.
Keywords: quant finance, quantitative, stock market, equities, global equities, global stocks, volatility, VIX, DeFi, decentralized finance, country index, stock market, developed markets, emerging markets, frontier markets, alpha, beta, investment product, quantitative finance, financial engineering
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