Index Investing

Extreme Risk and Downside Protection - the best papers of 2016

Extreme Risk and Downside Protection - the best papers of 2016

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Fat-tail frequencies and the new non-normal: how volatility extremes skew returns (Hermes, March 2016)
This paper from Hermes suggests that market volatility follows a broad pattern alternating between higher and lower volatility, with measurable impact on returns. Different volatility regimes suggest different risk management strategies and different tools for managing extreme risks.

2016 Long Term Capital Market Assumptions (JP Morgan, Oct 2015)
With over 2000 views on our site, this excellent 70 page document from JP Morgan dedicates 10% of the text to the modelling and managing of fat-tailed market risks.

Predicting Volatility (Lazard, 2015)
Volatility forecasting has huge implications for investors employing risk parity, volatility targeting and asset allocation strategies. This paper examines volatility prediction - its characteristics and the effectiveness of different approaches.

Dynamic downside protection (Russell Investments)
Since the global financial crisis, the new risk-on risk-off world that we have experienced has seen a heightened volatility of volatility. Investors are responding by seeking downside protection at a reasonable price. Some commonly available strategies that come at a cost (often considered prohibitive) are referenced in this paper.

We Don't Know What We Are Talking About When We Talk About Volatility (Nassim Taleb, 2007)
This influential 2007 paper from Nassim Nicholas Taleb and Daniel Goldstein explores the apparent confusion between mean absolute deviation and standard deviation. The mental confusion between these variables has a significant impact on the perception of market "volatility" and hence decision-making.

De-risking Goes Further than Interest Rate Risk: Dynamic Asset Allocation in an LDI Solution (GMO, March 2015)
Interest rate risk tends to be the main focus of Defined Benefit pension de-risking. However, those who have implemented a glide path approach tend to have are other key risks to consider. In this paper, GMO argue that valuation risk is the biggest risk.

Hedge funds in strategic asset allocation (Lyxor, Feb 2015)
This 60-page white paper looks at hedge funds in the context of Strategic Asset Allocation. While analysing the return characteristics of hedge fund styles, the author examines biases in fat tail risk, non-normal distribution and performance persistence, amongst other things.

Tail Risk of Smart Beta Portfolios: An Extreme Value Theory Approach (EDHEC, 2014)
Do smart beta strategies exhibit higher extreme risk? This is an important question because the improvement in the risk-adjusted performance of smart beta strategies is usually demonstrated in terms of the Sharpe ratio - if there is a substantial change in the thickness of the left tail of the smart beta return distribution which may be underestimated by volatility, then Sharpe ratios may mislead.

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