Volatility-Managed Volatility Trading

64 Pages Posted: 12 Apr 2024

Date Written: March 16, 2024

Abstract

We develop volatility risk premium (VRP) timing strategies that involve trading two assets: a volatility asset and a risk-free asset. We first analyze a benchmark portfolio with a constant negative weight on volatility assets each month. Then, we show that a volatility-managed portfolio, which reduces selling of volatility assets during periods of heightened volatility, considerably enhances long-run performance. Our findings are robust across three types of volatility assets - variance swaps, VIX futures, and S&P 500 straddles - and in the presence of transaction costs. An ex-post study indicates that timing portfolios yield positive alpha and reduce exposure relative to constant-weight portfolios, mostly during volatility-spike periods rather than stable periods. Our findings help differentiate asset pricing theories on risk-return relations in the volatility asset market.

Keywords: Variance Risk Premium Timing, Volatility-Managed Portfolios

JEL Classification: G01, G12, G17, G23

Suggested Citation

Yang, Aoxiang, Volatility-Managed Volatility Trading (March 16, 2024). Available at SSRN: https://ssrn.com/abstract=4761614 or http://dx.doi.org/10.2139/ssrn.4761614

Aoxiang Yang (Contact Author)

Peking University ( email )

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

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