This question is about a short-biased hedge fund. The SNP500 estimate is -0.572 which indicates “highly significant negative loadings on equity risk.” So, I understand that much.
But, does the -0.572 represent the change in the hedge fund return as a result of this factor? -.57%?
Near the beginning of Section 9.1, immediately following the bullet-pointed explanations of the conditional factor risk models, the text states that “Each factor beta represents the expected change in hedge fund returns for a one-unit increase in the specific risk factor, holding all other factors constant.”
I am confused here with short volatility. For short positions, we have higher volatility right? Here, they say negative VIX loading is consistent with short volatility exposure. I think it will be positive??
I do not understand this. Can anyone enlighten me?
During normal times, equity market trends upwards and equity volatility falls (R26, Exhibit 12, Page 62).
So if the VIX loading (during normal times) is negative, it means the strategy return is positive during normal times when volatility is falling. And that happens if you are selling options (in particular put options) because short option positions becomes in the money when volatility falls. As equity market is trending upwards, put option value declines further, resulting in a gain.
And it cannot be selling call options because equity market is trending upwards so the short call options would lose money even though volatility falls.
From the loading and the trend during normal times, you can deduce the strategy.
To continue from BB14, during Crisis periods, the VIX loading becomes -0.164 + DVIX 0.105 = -0.059.
During crisis periods, equity falls sharply and volatility rises, which leads to loses for the strategy (given the put options become more valuable to the long, which is bad for the writer). That’s how the negative VIX loading is interpreted in crisis periods.