We present extensive evidence that "risk premium" is strongly correlated with tail-risk skewness but very little with volatility. We introduce a new, intuitive definition of skewness and elicit an approximately linear relation between the Sharpe ratio of various risk premium strategies (Equity, Fama-French, FX Carry, Short Vol, Bonds, Credit) and their negative skewness. We find a clear exception to this rule: trend following has both positive skewness and positive excess returns. This is also true, albeit less markedly, of the Fama-French "Value" factor and of the "Low Volatility" strategy. This suggests that some strategies are not risk premia but genuine market anomalies. Based on our results, we propose an objective criterion to assess the quality of a risk-premium portfolio.
The performance of trend following strategies can be ascribed to the difference between long-term and short-term realized variance. We revisit this general result and show that it holds for various definitions of trend strategies. This explains the positive convexity of the aggregate performance of Commodity Trading Advisors (CTAs) which -when adequately measured -turns out to be much stronger than anticipated. We also highlight interesting connections with so-called Risk Parity portfolios. Finally, we propose a new portfolio of strangle options that provides a pure exposure to the longterm variance of the underlying, offering yet another viewpoint on the link between trend and volatility.
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