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Trend Following, Long-Term Variance, and Tail Protection

Article arXiv papers · Author: Tung-Lam Dao et al.
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Summary

The document explains trend following through the difference between long-term and short-term realized variance. It says this relationship applies across several definitions of trend strategies and helps explain the positive convexity of aggregate CTA performance. The authors argue that this convexity is stronger when measured appropriately, though the description gives no data, measurement details, or numerical results with which to assess that claim.

It also connects trend strategies with Risk Parity portfolios and proposes a portfolio of strangle options designed to isolate exposure to an underlying asset’s long-term variance. The strangle construction offers another way to examine the relationship between trend and volatility. The summary does not specify implementation choices, market coverage, costs, or empirical limitations, so it supports a conceptual overview rather than a practical trading assessment.

Key ideas

  • Trend strategy performance is linked to the difference between long-term and short-term realized variance.
  • The authors say the variance relationship holds across several definitions of trend following.
  • Proper measurement reveals stronger positive convexity in aggregate CTA performance than anticipated.
  • The document draws a connection between trend strategies and Risk Parity portfolios.
  • A proposed strangle portfolio aims to provide exposure to long-term variance.

Tags

Trend followingVolatilityOptionsRisk management
Full text
# Tail protection for long investors: Trend convexity at work


# Tail protection for long investors: Trend convexity at work









The performance of trend following strategies can be ascribed to the difference between long-term and short-term realized variance. We revisit this general result and show that it holds for various definitions of trend strategies. This explains the positive convexity of the aggregate performance of Commodity Trading Advisors (CTAs) which -- when adequately measured -- turns out to be much stronger than anticipated. We also highlight interesting connections with so-called Risk Parity portfolios. Finally, we propose a new portfolio of strangle options that provides a pure exposure to the long-term variance of the underlying, offering yet another viewpoint on the link between trend and volatility.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.