Objective research and reviews to aid investing decisions
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Reward goes with risk, and volatility represents risk. Therefore, volatility means reward -- investors/traders get paid for riding roller coasters. Right? Well, sometimes yes and sometimes no. Here is a listing of past blog entries related to the volatility effects:
Seasonal Environmental Factors and Perceived Risk ...traders may be able to exploit predictable seasonal changes in implied volatility that derive from the effects of investor mood on perceived risk and not from variations in actual risk.
Do Informed Traders Tip Their Hands Via Option Purchases? ...evidence supports beliefs that informed traders distort the relationship between the prices for put and call options on individual stocks and that others may be able to exploit these distortions. Relatively expensive calls (puts) predict stock outperformance (underperformance).
Trend Implications of Big Up and Down Days ...big up and down days appear to have some tendency to cluster, with such volatility clusters associated more with market bottoms than with continuing downtrends.
Misunderestimating Volatility? ...sloppiness in applying statistics can lead to severe misestimates of variability. People should rely on definitions, not intuitions, in assessing volatility.
Sources of Volatility's Predictive Power for Stock Returns ...volatility-based portfolio strategies derive their effectiveness from: (1) the difference between realized volatility and implied volatility ; and, (2) the difference between call-implied volatility and put-implied volatility.
(Low) Volatility as an Indicator of Persistent Hedge Fund Outperformance ...low volatility of returns is key to identifying persistent outperformance among hedge funds.
Short-term Relative VIX Level as a Trading Signal ...the TradingMarkets 5% VIX rule is of limited practical use and does not support a standalone trading strategy that keeps up with buy-and-hold.
The Long and Short of Beta ...stock betas change over time, and strategies that track these changes with high-frequency data can generate abnormal returns. Stocks with long-term high (low) but recently decreasing (increasing) betas are buys (sells).
Low Risk and High Return? ...investors overpay for volatile stocks over the long haul, most dramatically during bear markets.
Fear Factor? ...implied or expected volatility (VIX) should tentatively be viewed as a fifth factor in modeling stock returns because it affects them both directly in a multi-factor model and indirectly through the other risk factors.
Some Notes on Variability of Stock Market Returns ...How should the variability of stock market returns shape the outlooks of short-term traders and long-term investors? How strong is the tailwind of the general drift upward in stock prices? How powerful is the turbulence of variability? Does the tailwind ever overpower the turbulence?
Screening for Fear When Portfolio Building ...the volatility premium for individual stocks derives from volatilities implied by options prices rather than historical (realized) stock price volatilities. This premium may be concentrated in small growth stocks.
Measuring Investor/Trader Risk Aversion ...when investors/traders are depressed, as measured by the gap between implied volatility and historical volatility, so are stock prices.
Risky Stocks + Short Sellers = Low Returns ...high short interest alone does not predict abnormally low future returns. Rather, high short interest for stocks that are particularly risky to trade (high idiosyncratic volatility) predicts low future returns. One interpretation is that, when short sellers take on hard-to-hedge positions, they exhibit stock-picking skill.
A Short-term VIX Trading Strategy That Works? ...VIX signals are useful for short-term switching between small-capitalization and large-capitalization stock indexes, especially when VIX is historically high.
Why Highly Volatile Stocks Tend to Underperform ...the idiosyncratic volatility premium is closely related to the value premium, with low volatility and high value stocks tending to outperform. Insensitivity to discount rate (inflation, interest rate...) shocks is the common underlying factor.
VIX as an Indicator for Different Kinds of Portfolios ...both the long-term and short-term behaviors of the VIX appear to have some value as an indicator of future stock returns, especially for high-beta stocks.
Predicting Stock Returns Not with Volatility, But Volatilities ...when experts cite overall stock market volatility as an indicator of future market behavior, they are only half right, which is about the same as wrong.
No Reward for Risk? Why Can't They Keep Their Story Straight? ...exceptionally volatile stocks are on average inferior investments, or at least trades. There is no reward for this kind of risk, and presently no explanation for this effect.
A Slinky (Short-term Reversion) Effect? ...extreme market declines (but not extreme market advances) present reversal trading opportunities with relatively high risk, but these opportunities are by definition infrequent and are not very evenly spaced over time.
VIX Fix ...history does not confirm that an extremely low VIX is a danger signal. However, a high (low) VIX provides weak indication of superior (inferior) future market returns. An extremely high VIX suggests good future returns.
In summary, high price volatility is generally a good sign for the overall stock market but a bad sign for individual stocks.
