Diversification

Returns of rolling short volatility index has many similarities to returns of bond index. 

 

Rolling short variance: 

- regular periods of positive P&L  

- ponctual large losses from spikes in volatility

 

Bond indices: 

- regular P&L resulting from coupon payments and accrued interest

- punctual capital losses caused by rising yields. 

 

The IV - RV premium can be thought of as the payment required for providing “equity-insurance” capital. 

 

Index short vs vs bond index

 

 

--> relatively low correlation between P&L from short variance and equity market --> diversification effect. 

--> variance returns not fully correlated to any combination of bonds and equities --> push out the efficient frontier. 

--> short VS often replace bonds within an efficiently allocated portfolio due to bond-like nature of short VS returns. 

 

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