University of Sussex
Browse

Diversification with volatility products

Download (698.35 kB)
journal contribution
posted on 2023-06-09, 03:09 authored by Carol AlexanderCarol Alexander, Dimitris Korovilas, Julia Kapraun
Recent changes to clearing-house regulations have promoted exchange-traded products offering risk premia previously accessible only over-the-counter. Thus, as correlations increase between equity, bonds and commodities, a new strand of research questions the benefits of home-grown diversification using volatility products. First we ask: “What expected returns will induce equity and bond investors to perceive ex-ante diversification benefits from adding volatility?” We call this the optimal diversification threshold. We derive the theoretical thresholds for minimum-variance, mean-variance and Black–Litterman optimization. Empirical analysis of US and European markets shows that volatility diversification is frequently perceived to be optimal, ex-ante, but these apparent benefits are almost never realized, being eroded by high roll and transaction costs. Exchange-traded volatility only proved an effective diversifier during the banking crisis. At other times long equity and bond portfolios diversified with volatility futures have not performed as well as those without diversification, or even those diversified with commodities.

History

Publication status

  • Published

File Version

  • Accepted version

Journal

Journal of International Money and Finance

ISSN

0261-5606

Publisher

Elsevier

Volume

65

Page range

213-235

Department affiliated with

  • Business and Management Publications

Full text available

  • Yes

Peer reviewed?

  • Yes

Legacy Posted Date

2016-09-28

First Open Access (FOA) Date

2017-09-17

First Compliant Deposit (FCD) Date

2016-09-28

Usage metrics

    University of Sussex (Publications)

    Categories

    No categories selected

    Exports

    RefWorks
    BibTeX
    Ref. manager
    Endnote
    DataCite
    NLM
    DC