Seminar (London) - Artur Sepp - Gaining the alpha advantage in vol trading

Full title: Gaining the alpha advantage in volatility trading

Abstract: We start by presenting some empirical evidence for short volatility strategies and the cyclical pattern of their P&L resulting in alpha in good times but beta in bad times.

We relate the risk-premium observed in volatility strategies as a compensation to bear losses in bad market regimes. While in normal market regimes the positive risk-premium contributes to the positive expected P&L for volatility strategies, large negative spikes in the risk-premium lead to sharp losses for vol strategies during bad market regimes. The million-dollar question is how to manage vol strategies with respect to market cycles?

First, we introduce a factor model to explain the risk-premium using the risk-aversion of investors and heavy-tails of returns distributions under the statistical measure.

Second, we consider an econometric model for statistical inference of market regimes and for optimal position sizing with respect to forecast probabilities of regimes.

Finally, we illustrate model applications for generating alpha from volatility strategies.

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Speaker: Artur Sepp works for Global Risk Analytics at Bank of America Merrill Lynch focusing on firm-wide risk-return optimization. Prior to that, he worked as equity and credit derivatives quant at Merrill Lynch and Bear Stearns with particular emphasis on credit and volatility modelling and trading. Artur has a PhD in Probability and Statistics from the University of Tartu in Estonia, an MSc in Industrial Engineering from Northwestern University in Chicago, and a BA in Mathematical Economics. His research area is on volatility models, computational methods, investment and trading strategies. Artur has published several research articles on quantitative finance in leading journals and he serves as an associate editor for the Journal of Computational Finance.