Volatility for asset allocation
| 23 December 2011 |
Shifts in volatility regime: a power tool for tactical allocation Volatility in asset pricing, though notoriously hard to predict, is a powerful tool when it comes to deciding tactical asset allocations. We have classified volatility into three regimes so as to overcome the unpredictability issue. Evaluating when shifts from one mode to another might occur, an easier task, is informed by our core and alternative economic scenarios. |
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Risk premiums are often cited as ideal tools for constructing asset allocations, but they suffer from two drawbacks. First, they are non-observable, nor can they be reliably estimated. Second, they are not constant. Volatility can be taken as a more suitable measure. Though inconstant and hard to predict as well, volatility falls into three distinct modes. Crucially, it is an observable phenomenon through implied volatilities. Like risk premiums, it offers a reliable barometer enabling investors to assess economic and systemic risks.
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Introduction to the "Topic of the Month" of our financial publication Perspectives, "2012: mixed outlook of reflation hopes and deflation fears", December 2011 edition. |
