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Overview

The extraordinary growth of short volatility strategies creates risks that may trigger a serious market crash. A low-yield, low-volatility environment has drawn various market participants into essentially similar short volatility-contingent strategies with a common nonlinear risk factor. We discuss these strategies, their commonalities, and the generally unrecognized risks that they would pose if everyone were to unwind simultaneously. Volatility-selling investors essentially provide “shadow financial insurance.” Investors and regulators would benefit from preparing for large, self-reinforcing technical unwinds that may occur when/if central banks change policy or macro or political events affect investor confidence. We also discuss potential mechanisms that might provide stabilization against largely adverse financial outcomes.

About the Author(s)

Vineer Bhansali

Vineer Bhansali is chief investment officer at LongTail Alpha, LLC, Newport Beach, California.

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Larry Harris CFA

Larry Harris, CFA, is Fred V. Keenan Chair in Finance at the USC Marshall School of Business, Los Angeles, and is lead independent director at Interactive Brokers.

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