Book Review: The Missing Risk Premium

Just finished reading Eric Falkenstein's new book The Missing Risk Premium. I have been a reader of Dr Falkenstein's blog for several years now, and have read his first book Finding Alpha, as well as his academic papers available on SSRN, so I'm quite familiar with the topic - CAPM is wrong, there is no extra return for volatile investments.

In the book Dr Falkenstein leaves no stone unturned in bringing empirical evidence that risk (however defined in a consistent manner) does not have positive correlation with returns, and at higher risk levels sometimes delivers smaller returns (suggesting negative correlation). To quote the book:

"There is no general tendency within a variety of investments such as equities, options, most of the yield curve, high-yield corporate and bankrupt bonds, mutual funds, commodities, small business owners, movies, lottery tickets, and horse races. Indeed, many high-risk assets actually have lower-than-average returns..."

In addition he proposes an alternative theory based on relative utility function - that is people pursue relative wealth and benchmark themselves to the "population" - which reduces risk premium to zero. Practical application suggested by author that one can beat the benchmark on a risk-adjusted basis if one avoids most volatile, or risky in the real sense investments that others make for exogenous reasons. As an example author provides sample Minimum Variance Portfolios that have the same components as leading equity indexes FTSE, MSCI-Euro, S&P500, Nikkei but with weights optimized to minimize volatility (details available in the book and also at  Dr Falkenstein's http://www.betaarbitrage.com/) , and tend to produce similar returns as indexes with about half of volatility.

The book is mostly technical, but without unnecessary math, and is focused on the main thesis - there is no "investment edge" in simply taking the risk. I would recommend every investor keep this in mind.

Bad prices on new Eurex website

A quick note - Eurex unrolled a new website over the weekend, but at the time of writing there is a small glitch  - if you look at individual futures contracts last and settlement prices are rounded to the whole Euro

SEP 2012
OCT 2012

but they appear normal for on a different page (select "all expiries" on the dropdown)

ALL EXPIRIES

P.S. Fixed.

Volatility Report / VSTOXX Robust Growth

Equity indexes were up/mixed and volatility futures were down this week. The volume is concentrated in the VIX (361318 contracts in the last week), followed by GVZ(449) and VXEM(352). Other CBOE products are showing very little interest - OVX (5 contracts) , VXEWZ (100), and VN(5).

VSTOXX remains the leader in overseas volatility futures trading 42409 contracts last week. In fact volume on VSTOXX futures and options is steadily growing.  I must note that options volume is dominated by block transactions, not screen volume, although futures volume is primarily screen volume. Here is a link to the figures from Eurex.

VSTOXX Futures in the US

CFTC certified Eurex VSTOXX futures to be eligible to be sold and traded by US investors. This creates opportunity for statistical arbitrage between two contracts that already have significant time overlap: VIX Futures open at 7 am Central Time, while VSTOXX Futures close AT 17:30, with with 7-hour difference creates overlap of 3 1/2 hours.

Exchange circular Eng, Deu. Related article from Risk magazine.