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Calculating daily volatility

Volatility is usually expressed as the annualized standard deviation of returns. Volatility is proportional to the square root of time. That means one can approximate a volatility over a smaller time period than one year by dividing the annual vol by the square root of the number of trading periods one is interested in.

So, to convert annual volatility to a daily vol, divide by 16, which is the square root of 256 — about the number of trading days in the year.

Back in the days when vol was 15-20% annually (way back in 2007), a daily vol was about 1%. These days, the VIX is closer to 80 which implies a daily return of +- 5%.

On Sept 15th, 2008, when Lehman was allowed to go bankrupt (“Lehman is not too big to fail” – Paulson), the VIX went up to 80 and has been in that region ever since. The Lehman bankruptcy has turned out to be a massive event in financial history.

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November 19, 2008 Posted by | Economics, Government, Investing | , , | Leave a comment

Is Volatility an Asset Class?

Others have weighed in on whether volatility should be considered an asset class. From the point of view of a long term investor it clearly doesn’t make sense to buy and hold volatility. (In that sense, it is the ultimate cyclical asset class and we should be glad we don’t live in a world of ever increasing volatility!). However, in terms of the diversification benefit for a portfolio, the VIX does exhibit low (and negative) correlation with many of the major asset classes. The table below shows the correlation matrix for major asset classes over the past 750 days, a period during which the VIX had negative correlation with US stocks and real estate and no correlation with European stocks. Notice, though, that a similar diversification benefit could probably have been achieved with a combination of treasuries and bonds.

    TIP AGG GSG VNQ EEM EFA VB VV
Ishares Lehman Ti TIP                
Ishares Leh Agg F AGG 0.95              
Ishares Gsci Cmdt GSG 0.90 0.78            
Vanguard Sf Reit VNQ -0.78 -0.69 -0.69          
Ishares Msci E.M. EEM 0.56 0.68 0.52 -0.37        
Ishares Msci Eafe EFA -0.14 0.05 -0.14 0.25 0.70      
Vanguard Sm Cap E VB -0.54 -0.38 -0.47 0.63 0.25 0.75    
Vanguard Lg Cap E VV -0.32 -0.12 -0.32 0.39 0.56 0.94 0.89  
Cboe Volatility I ^VIX 0.78 0.81 0.60 -0.80 0.55 0.00 -0.39 -0.14

Note: this chart was generated on the AssetCorrelation website which is an excellent resource for monitoring the diversification of your own portfolio.

September 23, 2008 Posted by | Economics, Investing | , , , , , , | Leave a comment