Volatility Effects

A reader asked: “You have had multiple blog entries regarding the erosion of price in leveraged funds due to re-balancing costs. Why are there long periods during which this erosion appears not to occur? I have been short both Ultra S&P500 ProShares (SSO) and UltraShort S&P500 ProShares (SDS) since June 1, 2009 and am losing money. Thoughts?” Keep Reading

Does the Chicago Board Options Exchange Volatility Index (VIX) have separable components of rational and irrational risk? If so, is the irrational risk component of use to investors? In their October 2009 paper entitled “Risk Sentiment Index (RSI) and Market Anomalies”, Guy Kaplanski and Haim Levy introduce the Risk Sentiment Index (RSI) as a measure of the residual risk contained in VIX after accounting for the statistical and economic variables most predictive of future stock market volatility (such as previous month actual volatility and VIX). They also analyze factors which affect RSI and its relationships with day-of-the-week and month-of-the-year stock market anomalies. Using daily closes for VIX and the S&P 500 Index during 1990-2007 (4,538 days) and for the Volatility Index Japan (VXJ) and the Nikkei 225 Index during 1995-2007 (3,200 days), they conclude that: Keep Reading

A reader asked: “Could you review the TFS Market Neutral (TFSMX) mutual fund the same way you reviewed the Hussman Strategic Growth (HSGFX) mutual fund? TFSMX is a market neutral mutual fund from the same firm that runs a market neutral hedge fund available only to accredited investors.” Using weekly adjusted prices for TFSMX during 9/7/04 (the earliest available) through 10/23/09 (268 weeks), along with comparable data for HSGFX, the S&P 500 Index and S&P Depository Receipts (SPY), we conclude that: Keep Reading

Typically, value means unexciting low-beta stocks, and momentum means exciting high-beta stocks. Does “typically” mean always? In their September 2009 paper entitled “The Changing Beta of Value and Momentum Stocks”, Andrea Au and Robert Shapiro investigate the relationships between beta and value and between beta and momentum under varying stock market conditions. Using monthly beta distributions for value (based on book-to-market ratio) and momentum (based on prior 12-month return) sorts of the Russell 3000 stocks over the period December 1978 through March 2009, they conclude that: Keep Reading

Does momentum trading (and its contrarian counterpart) work better for certain kinds of stocks? In their August 2009 paper entitled “Systematic Risk and the Performance of Mutual Funds Pursuing Momentum and Contrarian Trades”, Grant Cullen, Dominic Gasbarro, Gary Monroe and Kenton Zumwalt examine mutual fund trading activity and performance to measure the prevalence of and results for momentum and contrarian equity investing strategies. Using the quarterly stock holdings of 2,829 U.S. equity mutual funds and associated stock price data for the period 1991-2006, they conclude that: Keep Reading

The conventional wisdom is that annualized stock market volatility declines with investment horizon because of the moderating effect of mean reversion in returns. In the May 2009 version of their paper entitled “Are Stocks Really Less Volatile in the Long Run?” Lubos Pastor and Robert Stambaugh challenge this view by focusing on the reasonable expectations of investors dealing with uncertainty rather than data in hindsight. Using annual real (inflation-adjusted) returns and return predictors for the period 1802-2007 (206 years), they conclude that: Keep Reading

Is beta a useful risk management or leveraging tool for investors? Two May 2009 articles, “Beta = 1 Does a Better Job than Calculated Betas” by Pablo Fernandez and Vicente Bermejo and “Betas Used by Professors: A Survey with 2,500 Answers” by Pablo Fernandez, address this question by testing the reliability of beta measurements over time, across calculation methods and across data sources. Focusing on betas for the Dow Jones industrial stocks relative to the S&P 500 index, these articles conclude that: Keep Reading

Does the gap between the (sentiment-driven?) options-implied volatility and the (data-driven) expected volatility of the broad equity market predict future stock returns? In the May 2009 version of his paper entitled “Variance Risk Premia, Asset Predictability Puzzles, and Macroeconomic Uncertainty”, Hao Zhou examines the predictive power of this gap based on several ways to derive expected volatility from realized volatility. Using monthly values of the Chicago Board of Options Exchange Volatility Index (VIX) to calculate implied volatility and high-frequency intraday S&P 500 Index levels to calculate realized volatility over the period 1990-2008, along with contemporaneous data for traditional market predictors, he concludes that: Keep Reading

The intended characteristics of leveraged and inverse exchange-traded funds (ETF) are obvious. Do they have unintended characteristics that may make them unsuitable for some investors? In their April 2009 paper entitled “The Dynamics of Leveraged and Inverse-Exchange Traded Funds”, Minder Cheng and Ananth Madhavan investigate the dynamics, market impacts, unusual features and investor suitability of leveraged (2x and 3x long exposure) and inverse (-1x, -2x and -3x short exposure) ETFs. Using daily returns for many leveraged and inverse ETFs, they conclude that: Keep Reading

How closely do leveraged exchange-traded funds (ETF) track their nominal, short-term design leverages over extended holding periods? In their February 2009 paper entitled “Long Term Performance of Leveraged ETFs”, Lei Lu, Jun Wang and Ge Zhang measure the realized leverages for several Ultra (2x) and UltraShort (-2x) ETFs from the ProShares family. Using daily returns for Diamond Trust Series 1 (DIA), S&P Depository Receipts (SPY), PowerShares QQQ (QQQQ) and iShares Russell 2000 Index (IWM), and for their corresponding 2x and -2x ProShares leveraged ETF pairs, from inception of the leveraged funds through December 15, 2008, they conclude that: Keep Reading