Harvesting the Downside Beta Premium with the Implied Volatility Term Structure: The Cinderella Strategy
Copyright policy )Harvesting the Downside Beta Premium with the Implied Volatility Term Structure: The Cinderella Strategy
Ang, Chen and Xing have shown in "Downside Risk" that stocks that covary strongly with the market during market declines have high average returns. The reward for bearing downside risk is not simply compensation for regular market beta, nor is it explained by coskewness or liquidity risk, or by size, value, and momentum characteristics. The downside beta premium is not for free. The drawdown is considerable amplified in times of market troubles. This working paper combines the results of Ang, Chen and Xing with a signal based approach developed in a previous working-paper. The implied-volatility-term-structure (IVTS) classifies market regimes. One invests only in the favorable regime fully into stocks with high downside beta. Due to this classification the downside beta premium is (almost) a free lunch.
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