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A Constant-Volatility Framework for Managing Tail Risk

Alexandre Hocquard, Sunny Ng and Nicolas Papageorgiou
The Journal of Portfolio Management Winter 2013, 39 (2) 28-40; DOI: https://doi.org/10.3905/jpm.2013.39.2.028
Alexandre Hocquard
is the director of quantitative strategies and portfolio manager at Pavilion Advisory Group Ltd. in Montréal, QC, Canada.
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  • For correspondence: alexandre.hocquard@hec.ca
Sunny Ng
is director of research at Morningstar Asia in Hong Kong.
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  • For correspondence: sunny.ng@morningstar.com
Nicolas Papageorgiou
is associate professor of finance at HEC Montreal and director of quantitative research at Pavilion Advisory Group Ltd. in Montréal, QC, Canada.
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  • For correspondence: nicolas.papageorgiou@hec.ca
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Abstract

Since Lehman Brothers collapsed in 2008, tail-risk hedging has become an increasingly important concern for investors. Traditional approaches, such as purchasing options or variance swaps as insurance, are often expensive, illiquid, and result in a substantial drag on performance. A more prudent, cost-effective way to maintain a constant risk exposure is to actively manage portfolio exposure according to the prevailing volatility level within underlying assets. The authors implement a robust methodology based on Dybvig’s payoff distribution model to target a constant level of volatility and normalize monthly returns. This approach to portfolio and risk management can help investors obtain their desired risk exposures over both short and longer time frames, reduce exposure to tail risk, and in general increase portfolios’ risk-adjusted performance.

TOPICS: Tail risks, volatility measures, financial crises and financial market history

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The Journal of Portfolio Management: 39 (2)
The Journal of Portfolio Management
Vol. 39, Issue 2
Winter 2013
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A Constant-Volatility Framework for Managing Tail Risk
Alexandre Hocquard, Sunny Ng, Nicolas Papageorgiou
The Journal of Portfolio Management Jan 2013, 39 (2) 28-40; DOI: 10.3905/jpm.2013.39.2.028

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A Constant-Volatility Framework for Managing Tail Risk
Alexandre Hocquard, Sunny Ng, Nicolas Papageorgiou
The Journal of Portfolio Management Jan 2013, 39 (2) 28-40; DOI: 10.3905/jpm.2013.39.2.028
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  • Article
    • Abstract
    • TRADITIONAL TAIL-RISK MANAGEMENT TECHNIQUES: PORTFOLIO INSURANCE
    • RE-THINKING VOLATILITY: BLACK SWANS VERSUS WHITE SWANS
    • THE VOLATILITY OF VOLATILITY: A STORY OF TWO TAILS
    • DYNAMIC EXPOSURE AND CONSTANT VOLATILITY
    • THE PAYOFF DISTRIBUTION MODEL
    • MODEL IMPLEMENTATION
    • IMPLEMENTING A CONSTANT VOLATILITY OVERLAY ON A PORTFOLIO
    • RESULTS
    • VOLATILITY REGIMES AND ASSET RETURNS
    • ROBUSTNESS TO TARGET VOLATILITY
    • ROBUSTNESS TO INDICES
    • CONCLUSION
    • ENDNOTES
    • REFERENCES
  • Info & Metrics
  • PDF (Subscribers Only)
  • PDF (Subscribers Only)

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