Buy rough, sell smooth

Paul Glasserman and Pu He

Quantitative Finance, 2020, vol. 20, issue 3, 363-378

Abstract: Recent work has documented roughness in the time series of stock market volatility and investigated its implications for option pricing. We study a strategy for trading stocks based on measures of their implied and realized roughness. A strategy that goes long the roughest-volatility stocks and short the smoothest-volatility stocks earns statistically significant excess annual returns of 6% or more, depending on the time period and strategy details. The profitability of the strategy is not explained by standard factors. We compare alternative measures of roughness in volatility and find that the profitability of the strategy is greater when we sort stocks based on implied rather than realized roughness. We interpret the profitability of the strategy as compensation for near-term idiosyncratic event risk.

Date: 2020
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DOI: 10.1080/14697688.2019.1675899

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