Tuesday, September 17, 2013

mean reversion - vol^pair^underlier price

I feel implied vol shows more mean reversion than other "assets" (pretending eq vol is an asset class). In fact Wall Street's biggest eq-vol house has a specific definition for HISTORICAL vol mean-reversion -- "daily HISTORICAL vol exceeding weekly HISTORICAL vol over the same sampling period". In other words "vol of daily Returns exceeding vol of weekly Returns, over the same sampling period". I think in the previous sentence "vol" means stdev.


This pattern is seen frequently. To trade this pattern, buy var swap, long daily vol and short weekly vol... (but is it h-vol or i-vol??) I am not sure if retail investors could do this though.

In contrast, Stocks, stock indices, commodities and FX can trend up (no long term mean reversion). Fundamental reason? Inflation? Economic growth?

The (simplistic) argument that "a price can't keep falling" is unconvincing. Both IBM and IBM - 2 yr option can rise and fall.  However, IBM could show a strong trend over 12 months during which it mostly climbs, so a trader betting big on mean reversion may lose massively. The option can have a run, but probably not too long. I feel volatility can't have long term trends.

A practitioner (Dan) said mean reversion is the basis of pair trading. I guess MR is fairly consistent in the price difference between relative value pairs.

Interest rate? I feel for years IR can trend up, or stay low. I guess the mean reversion strategies won't apply?

I feel mean reversion works best under free market conditions. The more "manipulated", the more concentration-of-influence, the less mean reversion at least over the short term. Over long term? No comments.

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