Abstract:
While attractive, VRP returns are highly pro-cyclical and the drawdowns are acute. Participants have looked to improve the risk profile through cross-market replication, market timing and buying low delta, theta-efficient options. These methods face multiple drawbacks. We introduce a new approach to cross-asset VRP investing, based on (1) forecasting volatility using a parametric, risk factor-based model and (2) using our knowledge of spot market returns to delta hedge better.
Caio Natividade is Head of Cross Asset Quantitative Research at Deutsche Bank.