1 Department of Business Studies, Aarhus School of Business, Aarhus BSS, Aarhus University2 Finance Research Group, Aarhus School of Business, Aarhus BSS, Aarhus University
The advents of long/short trading strategies with dynamic participation
This article aims to shed a light on innovative fund management concepts which emerged after the crisis. Two main strategies seem to dominate the financial turmoil: Absolute return concepts and long/short trading techniques. While there already exists exhaustive literature on absolute return concepts, next to nothing is known about position reverting strategies and how, and -even more important- in which context they are applied in practice. In the recent market downturn only one sector generated signicant profits for the leading investment banks: Volatility trading activities, namely on Forex, interest rates and commodities. If an investor positions himself on the (volatility) market within a long/short trading framework, he typically bets on a traditional mispricing arbitrage. However as this corresponds to a call spread with equal exercise prices, this strategy alone would not generate enough profit on well-developed markets. Dynamic participation features on cross asset portfolios are at rst sight a remedy to that dilemma. Based on volatility thresholds and portfolio re-balancing, the fund engineers try to create a "volatility guaranteed" investment opportunity by surfing on the unusual high market volatility induced by the financial crisis. We analyze the underlying concepts and quantify risks inherent to this new fund type and hence clarify hurdles for potential investors. We also aim to come up with an analytical pricing formula that could easily outperform simulation techniques used in industry so far.