The true volatility of payday loans
A special situation occurs in the high-yield sector. The illiquidity in large parts of the universe causes price lags meaning that the aforementioned small changes in credit quality are not immediately reflected in bond prices. In the economic literature, this effect is known as non-trading. With respect to high-yield indices non-trading and non-synchronous trading of index bonds can lead to autocorrelation of returns. Therefore, estimates of the index volatility for illiquid asset classes can be distorted. Usually the true volatility of illiquid asset classes is underestimated. In a portfolio context too large portfolio weights are the consequence. Especially portfolios constructed in the classical mean–variance framework suffer from that problem.