Shedding Light on Alternative Beta : A Volatility and Fixed Income Asset Class Comparison

Volatility is an alternative betaa risk premium captured by hedge fund managers and investment bank proprietary tradersthat is today moving closer to the mainstream and should be thought of as a veritable asset class.

Author(s):

David E. Kuenzi

Head of Risk Management and Quantitative Research, Glenwood Capital InvestmentsResearch Associate with the EDHEC Risk and Asset Management Research Centre

For many investors, it is difficult to derive intuition as to why volatility should deserve an ongoing allocation within a larger portfolio. If volatility is an asset class, then to what accepted asset class can it be compared? Why is there a risk premium over the long-term for investing in this asset class? Who is willing to pay this risk premium and why? In what environments might the risk premium be too narrow or negative and in what environments might it be substantial? These are critical questions for the institutional investors attempting to diversify various systematic exposures (or beta exposures) across a broader portfolio. There is a strong case that a volatility investor can expect to earn positive returns over time just as a fixed income, credit, or equity investor would. To best understand this, it is helpful to compare the volatility asset class to the fixed income asset class. As such, the purpose of this paper is to explore the likenesses between volatility and fixed income in order to more firmly establish the case for volatility as an asset class.

Type: Working paper
Date: le 02/04/2007
Research Cluster : Finance

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