Volatility expansion - test on back-adjusted data
Posted: Sun May 18, 2003 3:12 am
Say you are designing a system that looks for low vol and then a rapid expansion... pretty vanilla stuff.
I believe that testing such a system on back-adjusted data does not work. Make a series that rolls on OI. The spot contract will stay in place until OI drops below that of the next contract in the series. In many markets, often short dates i-rates, the volatility will drop off into expiry as OI falls. Then the new contract is appended to the data and that new contract is displaying 'normal' volatility. If you look at the back-adjusted series it will appear as though the market went very quite and then had a big volatility expansion and this point lines up very nicely with the roll date from one contract to the next (in the back-adjusted series). This, to me, is a fake volatility expansion.
Someone must have dealt with this?
Is there a back-adjusting method that accounts for differences in volatility?
thanks yet again for any feedback.
damian
I believe that testing such a system on back-adjusted data does not work. Make a series that rolls on OI. The spot contract will stay in place until OI drops below that of the next contract in the series. In many markets, often short dates i-rates, the volatility will drop off into expiry as OI falls. Then the new contract is appended to the data and that new contract is displaying 'normal' volatility. If you look at the back-adjusted series it will appear as though the market went very quite and then had a big volatility expansion and this point lines up very nicely with the roll date from one contract to the next (in the back-adjusted series). This, to me, is a fake volatility expansion.
Someone must have dealt with this?
Is there a back-adjusting method that accounts for differences in volatility?
thanks yet again for any feedback.
damian