portfolio hedging with interest rate volatility · portfolio hedging with interest rate volatility...
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Portfolio Hedging with Interest Rate Volatility
CBOE RMC Europe, 5 September 2014
Presented by Yoshiki Obayashi, Managing Director, Applied Academics LLC In collaboration with Prof. Antonio Mele, Swiss Finance Institute and CEPR
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THE RICH WORLD OF FIXED INCOME VOLATILITY
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Realized(Vola+li+es((1(month(rolling)(
USSW10"
CDX"
EDA"
SPX"
TYA"(right"axis)"
Equity market volatility alone cannot describe uncertainty in the financial markets at large
Hedging properties of VIX have been well-studied; what about those of interest rate volatility?
CBOE RMC Europe 2014!
3! CBOE RMC Europe 2014!
OPTION-IMPLIED VOLATILITY INDEXES
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Lognormal)Vo
l)(%)
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al)Vo
l)(bp
s))
CBOE"SRVX"
BAML"MOVE"
CS"CIRVE"
CBOE"VIX"(right"axis)"
CBOE"VXTYN"(right"axis)"
Interest rate volatility measures take on di!erent forms: price vs. yield & percent vs. basis point
CBOE’s unified volatility indexing methodology based on model-free variance swap pricing
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CBOE VXTYN℠ AT A GLANCE
Index: CBOE/CBOT 10-year US Treasury Note Volatility Index
Formula:
Launch Date: May 2013 by Chicago Board Options Exchange
Horizon and underlying tenor: Rolling 30-day forward on 10y T-Note futures
Skew Points: All calls and puts with non-zero bids, except for those outside of two consecutive zero bids
Data Sources: CBOT / CME Globex
Publication: VXTYN Index <GO> on Bloomberg
CBOE RMC Europe 2014!
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VXTYN AND BOND PORTFOLIO RETURNS
Relationship between VXTYN and a diversified bond portfolio appears to strengthen in times of heightened concern specifically about the interest rate component of portfolio returns
VIX appears to possess marginal explanatory power for other bond return factors
CBOE RMC Europe 2014!
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IF ONE COULD HEDGE WITH VXTYN INDEX RETURNS
A naïve beta-weighted hedging strategy using “returns” on VXTYN index levels kicks in during major drawdowns to smooth bond portfolio returns
During the same period, VIX has little to say about AGG
CBOE RMC Europe 2014!
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THE OPPOSITE HOLDS FOR S&P 500
A naïve beta-weighted hedging strategy using “returns” on VIX index levels kicks in during major drawdowns to smooth equity portfolio returns
During the same period, VXTYN has little to say about SPX
CBOE RMC Europe 2014!
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BUT CHANGES IN INDEX LEVELS AREN’T TRADABLE
The S&P 500® volatility term structure is generally in contango
The persistent roll-down of VIX futures makes naïve hedging strategies costly
What might we expect for VXTYN futures?
CBOE RMC Europe 2014!
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NO-ARBITRAGE MODEL OF VXTYN FUTURES
Mele, Obayashi, and Yang (2014) derive a no-arbitrage model of VXTYN futures and options
Model parameters may be calibrated to the: • level of VXTYN and the term structure of Treasury yields • times series properties of realized TY volatility (levels, variation, and mean-reversion) • term structure dynamics of option-implied TY volatility
CBOE RMC Europe 2014!
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HEDGING WITH CALIBRATED VXTYN FUTURES
CBOE RMC Europe 2014!
Simulated hedging returns display an upward drift from a “roll-up” e!ect and perform even better than hedging with cash index “returns”
Too good to be true? We shall find out once VXTYN futures start trading!
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FUTURE RESEARCH
CBOE RMC Europe 2014!
Devise more sophisticated hedging strategies based on simulated VXTYN futures prices
Generate and analyze simulated VXTYN options prices
Explore portfolio hedging strategies using both VIX and VXTYN derivatives
Research yield enhancement strategies based on VXTYN derivatives Contact: [email protected] Data Sources: CBOE and Bloomberg Important Disclaimer: The information contained in this presentation is provided for educational purposes only, and does not constitute investment, securities or trading advice.