Understanding the volatility-volatility relationship is crucial for option pricing and risk management.
Global economic conditions, central bank policies, and inflation expectations drive interest rate movements in government bond markets.
Deep dives
US government bond market volatility
The US government bond market has experienced significant volatility in recent years, with dramatic fluctuations in the move index. This volatility has presented challenges and opportunities for investors. Deep Kumar, the CIO of Triple-I Capital Management, discusses his strategies for finding value in global government bond markets, utilizing relative value strategies, and utilizing derivatives to seek out asymmetric return opportunities.
The concept of volatility itself being volatile
Deep Kumar discusses how volatility itself can be volatile, which has implications for option pricing and risk management. He reflects on previous market events, such as LTCM in 1998 and the 2008 financial crisis, where low volatility periods were followed by sudden spikes in volatility. He emphasizes the importance of understanding the relationship between volatility and leverage, and how it can contribute to the creation of risk blow-up environments.
The impact of global economic conditions on interest rates
Deep Kumar analyzes the impact of global economic conditions on interest rates. He discusses the significance of factors such as central bank policies, quantitative easing, and inflation expectations in driving interest rate movements. He specifically highlights the market's response to fiscal easing measures implemented after the Biden election and the resulting increase in inflation. He also explores the yield curve control framework in Japan and the implications of the Corovent kink in the JGB yield curve.
Positioning for potential market risks
Deep Kumar outlines potential areas of vulnerability and market risks going forward. He points out the risks associated with Japan's easing policies, the ECB's plans for quantitative tightening and reduction of its balance sheet, and the potential impact of the US debt ceiling issue. He emphasizes the importance of monitoring global economic and policy developments, as they can have significant implications for risk assets and fixed income markets.
Among the major asset classes, no market has experienced a sea-change in volatility levels more so than the US government bond market over the past few years. Consider that the MOVE index reached the low 40’s in 2019, spiked to 160 during the March’20 Covid market crisis, descended below 40 in late 2020 and then surged in 2022, again reaching 160. It is against this fast-changing risk backdrop, and exceptionally high vol of vol that I had the pleasure of welcoming Deep Kumar to the Alpha Exchange.
The Co-CIO of III Capital Management, Deep is engaged in finding value in global government bond markets, deploying relative value strategies across the curve and utilizing derivatives to seek out asymmetric return opportunities. Armed with a PhD in hypersonics, Deep hit Wall Street in the mid 90’s, building risk and pricing models that leveraged his understanding of the math that underpins derivatives pricing. Our discussion looks back on some of the formative events that Deep has encountered and how those have cemented the idea that volatility itself is volatile, a notion that matters in option pricing, especially when risk managing exposure to deep out of the money strikes.
The back half of our discussion considers the here and now and what Deep sess in the prices on hand. In Japan, we discuss the JGB yield curve “Kuroda Kink” and relate the importance of positioning – in this case by the price insensitive BoJ – in impacting market clearing prices. On the US front, he sees excess optimism reflected in the belly of the yield curve, where the meaningful inversion between 3-month bills and 2 year notes suggests an ongoing trend in disinflation that will enable the Fed to begin easing in 2023. Skeptical that this can occur perfectly according to plan, Deep is using OTC derivative trades that capitalize on a reversal of the negative term premium currently priced in the curve.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Dr. Deep Kumar.
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