One of those hidden risks stems from the daily rebalancing of the products, which takes place at each market close. Over a year, volatility in the products is likely to realise with little error, because there are 252 closing prices on which to draw. But over a month, say – just 20 trading days – the same may not be true. Put another way, the vol-target mechanism stabilises long-term volatility, but fails to account for short-term moves.
Ultimately, wherever we are innovating, what we care about is that we can hedge all of these innovations Hichem Souli, BofA BofA’s fix is a high-frequency rebalancing technique – so-called ‘fast convergence’ technology – that swells the number of observations and bolsters the rebalancing opportunities from just 20 to hundreds, or even thousands depending on the preferred fixing period. This allows the index to quickly lever up or down in response to intraday shifts, stabilising short- as well as long-term volatility.
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