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Convexity as a Factor

Finally, a Free Lunch?

Abhik Roy, CFA
10 min read
17 Nov 2024

SUMMARY

  • Convex stocks provided tail risk protection over the last 20 years
  • However, a long-short convexity index would have underperformed the stock market
  • The hedging characteristic is limited to the short side of the portfolio

INTRODUCTION

Higher returns in finance are generally associated with higher risk and vice versa. As a straightforward example, we have previously researched leverage as a tool to increase performance but it comes with a higher risk and a deteriorating Sharpe (read Outperformance via Leverage). Similarly, buffered ETFs offer lower risk but underperform markets over a long period and can simply be replicated using a diluted equity exposure.

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