The Vxx is an etn so you run Barclays credit risk. 90 percent of my risk is in vol. it has been for 15 years. I do not consider vol an asset class any more than I would consider convertible arbitrage an asset class. In my opinion an asset class should have a real asset. You use asset classes to create risk profiles. Bonds are an asset class. You can buy bonds to express views on credit and on interest rates. Neither of those are asset classes. Volatility is a risk factor in options. I wouldn't consider it an asset. I would not consider an option an asset though it can express a risk factor associated with another asset class synthetically.
No, you just said short vol produces a one time capital gain in an equity as its future cash flows get discounted at a more favorable rate.
"Is Volatility an Asset Class?" My 2 cents: No, of course not, if vola by itself! (Just like any other indexes) However, holding (long) futures on Vola or their options is an asset class. Selling (short) is not.
Try again. This is exactly what I said: "No. An asset is defined as something that can generate cash flows. Not something that goes up in time. It has value in time. There is such an asset that generates cash flows from short vol and that is equities. They benefit over time from a lower risk premium since their future cash flows are discounted over time by this risk premium therefore lowering the risk premium raises the present value of those future cash flows." And yes, what I said is correct. You're welcome.
You don't seem to understand what you said. The lowering of the risk premium can only be a one-off event. It's in effect an increase in the say, P/E ratio of the stock. It moves up to a certain point not go up forever. Therefore it can only be a one-off boost to returns(only if the move is favorable, it can be a drag as well if P/E decreases/risk premiums go up). Your definition of an asset as something that produces cash flow precludes short vol as an asset. Just because equities have exposure to short vol doesn't make short vol an asset per your definition. I'm not arguing that equities have short vol exposure. I think your definition of an asset is wrong, besides the fact that you are misapplying it.
Interesting conversation here. Starting from the theoretical side, in a complete market with efficient pricing, continuous trading and hedging, no jumps, and purely time-dependent volatility, you can isolate the volatility perfectly and earn the risk-free rate on a hedged portfolio. So in this sense, trading volatility is equivalent to investing in risk-free bonds. Taking the textbook definition of an asset (PV of a stream of future cashflows over some duration), volatility is an asset, albeit one equivalent to risk-free bonds. In practice, at least with exchange traded options, you cannot replicate volatility perfectly. At best, you're performing an approximation. Because of this, the return on a replication strategy is no longer risk-free, and new risk premia emerge (skew, kurtosis). I think someone (I believe destriero) made a good point in that the best examples of vol as an asset class lie in the family of swaps. Var swaps are certainly a far cleaner method of isolating variance as opposed to discretely delta hedging options. Gamma swaps, skew swaps...these instruments offer exposures to higher moments that portfolios of other conventional securities cannot (save embedded options in bonds or negative convexity in MBS, etc.). Volatility will never go to zero, or we would have a degenerate market. So as long as you believe the market will keep trading this stuff, variance, vol, gamma, skew, jumps, will all have unique values to market participants. And because of that, I believe they warrant treatment as their own asset class. Yes, the textbook definition of an asset is the capitalized NPV of future cash flows. However, I think a far better/realistic definition is that an asset is anything the market assigns monetary value to and is willing to swap currency, gold, or any other store of value for. Hope all are enjoying the weekend.
That is not correct. There is no "jump" in value. The "discount" rate, which is what the world uses to discount future cash flows of any asset has a risk premium embedded in that rate. That rate changes on a daily basis. The discount rate I assign to XYZ today will be different then the one I assign tomorrow given new information. This is finance 101. You might want to google discount rates and NPV before you hop back on the train here.
The issue I have here is that asset classes were kind of created in the financial community to sell the idea of diversification, not leverage. One could theoretically make the argument for long vol being an asset class as it is not correlated with other assets except maybe long bonds. Short vol though is highly correlated with long equities so if one is adding this asset class as a way of diversifying away from equity risk, they will actually be adding to it. Yes, variance swaps are cleaner at isolating vol but they are bounded by definition right? Do we have such an asset that exhibits bounded behavior that we consider asset? I mean there is no long term appreciation potential in a var swap so I view this only as a short term product. Perhaps short term asset?
Interesting question. But aren't there many assets that are bounded? Theoretically, a simple treasury bond is bound by 0, since market participants would just hold physical cash instead of accepting negative rates. Obviously, we are in the midst of a lot of central bank experimenting with NIRP and it is now readily apparent that empirically, rates can breach the zero lower bound, although I doubt by too much. I would say that a lower bound still exists, just somewhat lower than thought. Moreover, aren't T-bills considered assets? They may have short lives, but they are still considered to be assets. Investors just roll them to produce a virtually continuous investment in the T-bill asset class. So couldn't the same argument be applied to a long or short vol portfolio?