Volatility Risk refers to the impact on a portfolio of the unexpected changes in volatility. On the one hand, volatility risk involves changes in derivatives’ prices due to the unpredictable changes in the volatility of the underlying assets. In that respect, only derivatives are exposed to volatility risk. On the other hand, some trading strategies show diverse performance during different volatility cycles, even though derivatives are not presented in the portfolio. Sometimes hardly explainable, this phenomenon has to be taken into account when analyzing hedge fund performance. A strong correlation with market volatility can be used for forecasting the future performance.
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