BB 14 on page 67 says that for short biases strategy has negative loading for volatility.
My confusion here is that this strategy should have positive or negative volatility exposure?
Can anyone explain?
In their solution they explain it: the fund has short volatility exposure in addition to short equity exposure, suggesting that it may be selling puts against some of its short positions. The short volatility position isn’t a consequence of the short equity position; it’s an _ active strategy _.
not clear to me.
First, they have a short bias on equity. That would normally suggest a positive exposure to volatility.
Second, they have not a positive exposure to volatility, but a negative exposure to volatility, which means that, in addition to their short bias, they’re doing something else that gives them that negative exposure. That something else turns out to be that they’re selling puts.
short bias strategy should have a short exposure to equity. I understand that. Why is it supposed to have a positive exposure to volatility? I cannot connect the two here…
There was something in the reading about volatility exposure and equity exposure being inversely related. I’d have to hunt for it.
Whether you are short or long the equity, I believe you have positive exposure to volatility (volatility is +ve in either case as a sq root of a squared number)
However, the BB shows data that despite being short on equity, they are interestingly short volatility. This could mean they are selling puts as well. The t-statistic says they are -2.2 standard errors away from vix mean, which is significant.
As a side note, during crisis, however their Beta and vol exposures show, they are long on both aspects if I am reading this correctly.
Ok. Thanks for the response. What is the significance of t-stat here?
correct me if im wrong, but
short bias strategy means that at least some part of the fund consists of short sales (going by the definition given by nasdaq). in a short sale, you borrow the stocks to deliver to the buyer. you need to return the stocks at a later time by buying the stocks back in the market at the market rate and returning it to the original owner. that is, to close the short sale you need to long the stock, and that also means long the volatility in the stock. is that correct, or am i missing something?
Never mind-got it.
I don’t know why but I get a feeling OP is actually writing books on L3. No offence .
This may sound like a dumb question, but if they were shorting calls instead of puts would we still see negative volatility exposure PLUS increased negative equity risk exposure? Is this realistic of hedge funds? How would we know what position was taken if the incremental crisis time exposure for equity risk would decrease in both cases, except shorting calls would contribute to less of a decrease than shorting puts. Or maybe I’m just overthinking this…
shorting calls will give you positive exposure.