When one US carrier came to BofA, worried the FIA market could be strangled, Souli and his team went to the heart of problem – the underlying vol target index itself.
“The vol target itself is a simple and powerful mechanism, but there are still some risks in it and those have been neglected,” he says. 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.
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