Risk premium

We'll leave those aside for the moment because there's so many other dynamics happening in the office sector.

um but you know if you think about cap rates for uh industrial sort of in the sixes generally speaking um you know data center cap rates are more competitive they're generally speaking lower which is good for data centers but of course there's always a bit of a niggle in terms of where the 10-year treasury yield stands you know we've seen it really pushing up um more recently you know beyond four four and a half percent to 4.6 4.7 and so you know there's always the consideration of uh the shrinking risk premium um you know certainly i'm a big fan of all cre i think i've said this before on the show um but cre as wonderful as it is it is not you know a risk-free asset And so, you know, there's always that consideration when you start to get a risk premium that is shrinking where the cap rate is so close to the risk-free rate it doesn't really allow for a lot of wiggle room.

Let's talk about adaptive reuse.

I know some folks have done some conversions, right, of office properties or retail properties?

That's a really interesting example.

So over time, harvesting the volatility risk premia in QIS format has evolved.

And so it actually, the first strategies I was aware of, well, the first were probably the VIX roll trade.

Then it evolved into delta hedged straddles or strangles.

And the banks had the technology from when we were doing the original Delta hedge straddles to deliver instead a portfolio of options.

So that's when it did converge to.

And today, the most common VRP applications for just a very vanilla, how do I harvest the volatility risk premia in equities would be, for example, to sell on a daily basis a strip of options that are expiring in a week.

That would be the one over K squared variance replication portfolio.

You're setting a price for risk in the equity market, the equity risk premium, you set a price of risk in the bond market, it's a default spread.

Most of the time, the two move together.

What do I mean by that? If people get scared, there's a crisis, both equity risk premiums and default spreads go up.

If you're feeling really good, the price of risk in both markets comes down.

But there have been periods, especially in the last 25 years, where the two have moved in opposite directions.

All that will happen is you multiply it.

You need a risk-free rate, you need a beta of betas, and you need equity risk premiums.

just without even looking at the numbers, which of these should be the most straightforward of the three numbers to get,

you think?

When that goes, that crutch is now gone, right? I can't say there's one ratings agency that gets to...

Then I have no choice but to adjust for it.

For me, it's a little bit of a nightmare because so many of my risk premiums start with the U.S. equity risk premium But it's actually a mechanical adjustment where you have to adjust for the fact that you now have default spread in what you used to call your mature market base.

But it's doable.