Category: Investing Insight

Investing insight to make you a better investor.

A quick note on bonds

shyam October 14, 2015October 14, 2015 0

We compared the total returns from the short-end of the curve to Nifty. Here’s what we found:

IRR over the last 10 years for bonds was 6.53%.
Biggest drawdown was -5.04%.
Only two years of negative correlation with NIFTY.

Annual returns:

Equity curve:

Drawdowns:

The right place for bonds in a portfolio is for regular income. From a returns perspective, you are better off investing in equities. Bonds are no less volatile when compared to the returns they give, and are mostly correlated with equity volatility.

Categories Investing Insight, Your Money Tags bonds, mutual funds

Short-term vs. Long-term Rates

shyam October 12, 2015 0

Probably the reason why banks have been reluctant to pass on rate-cuts is because the yield curve has been flat as a pancake. The difference between short-term and long-term rates are near their historical lows.

Categories Investing Insight, Your Money Tags rates Formats Image

ARMA + GARCH to Predict VIX

shyam October 11, 2015 0

GARCH(1,1)

GARCH(1,1) is a common approach for modeling volatility. They were developed by Robert Engle to deal with the problem of auto-correlated residuals (which occurs when you have volatility clustering, for example) in time-series regression.

What we did:

Picked the best fit ARIMA(p,d,q) model for historical VIX over different look back periods
Created a GARCH(1,1) model based on ARMA(p,q)
Predicted t+1 VIX

500-day lookback

We found that modeling based on the previous 500-day VIX closing levels gave us the least prediction errors. The appendix has the charts for other lookback periods.

Prediction vs. Actual

Note how in some periods, the predicted value (red) is just the previous value.

Prediction error

Values less than zero implies that the model prediction overshoots the actual VIX level the next day.

Prediction vs. Actual Density Plot

The model bias towards higher estimation of VIX is made explicit here.

Next steps

We will integrate this model to our morning ‘Options Daily’ posts so that we get an idea of both the current state of VIX and the expected modeled behavior.

Caveats:

The 500-day lookback is purely empirical. Maybe some other look-back period that we have not tested would have been ideal to model. We will never know.
Only the known history can be modeled. The outputs should be used along with market determined proxies of expected volatility.
There is always a probability distribution around a predicted value. We will publish this in our daily posts.

Appendix

VIX Model vs. Actual across various lookback periods. (pdf)

quant.stackexchange

Volatility Forecasting I: GARCH Models, Rob Reider (pdf)

Categories Investing Insight, Your Money Tags quant, VIX

INDA vs. SPY Observed Volatility

shyam October 9, 2015 0

The iShares MSCI India ETF (INDA) tracks the MSCI India Total Return Index, representing about 85% of the Indian stock market. As a follow up to our earlier post on the historical volatility of the NIFTY , we thought we’ll compare the volatilities of INDA and SPY, the S&P 500 ETF.

10-day volatility:

50-day volatility:

As expected, a dollar denominated emerging market ETF is more volatile than the S&P. File this away in your brain attic.

Categories Investing Insight, Your Money Tags volatility

NIFTY Volatility, Historical Perspective

shyam October 9, 2015October 9, 2015 0

Was 2014 an anomaly?

Here’s a density plot of NIFTY volatility across 10-, 20-, 30-, and 50-day periods:

And here’s how it was in 2004 (10-years ago):

For those of who argue that the introduction of the pre-open auction call in 2010 skews these results, here’s how 2011 looked like:

The unprecedented absence of a second “hump” in the volatility density plot for 2014 should give pause to investors looking for a repeat of 2014 anytime soon.

Reversion to higher volatility?

If you look at the 50-day volatility over different time-periods, you can observe how volatile volatility is:

This year’s observed volatility is closer to last-year’s than to its long-term mean. Here’s how 2015 has panned out so far:

We should expect higher volatility as the initial bull-run wears off and volatility reverts. This will have a ripple effect on pretty much every investment/trading strategy.

Appendix

Year-wise NIFTY volatility density plots (pdf)

Categories Investing Insight, Your Money Tags NIFTY, volatility