Rebalancing and short volatility

Hi to everybody,

Rebalancing implies being short volatility. Why? Just because we get rid of existing positions and then cut volatility on those opened positions?

Thank you

It’s not quite as simple as they make it sound.

First, they need to define what they mean by “volatility”. Volatility of returns? (Probably not.) Volatility of prices? (Probably so.)

Assuming that they mean volatility of prices, and assuming that prices are increasing, then by rebalancing (returning to the initial target weights), you would sell securities with large price changes (selling high volatility) and buy securities with small price changes (buy low volatility). The net is a decrease in volatility.

Of course, if prices are decreasing, then rebalancing increases your volatility.

Thank you (again :wink:) for this answer.

In fact I read that in the summary of the reading « principles of asset allocation » but couldn’t find the concept elsewhere in the curriculum. Here is the short paragraph relating to my question:

« * Disciplined rebalancing has tended to reduce risk while incrementally adding to returns. Interpretations of this empirical finding include that rebalancing earns a diversification return, that rebalancing earns a return from being short volatility, and that rebalancing earns a return to supplying liquidity to the market. »