Which popular predictor is more useful to forecast international stock markets during the coronavirus pandemic: VIX vs EPU?

This study mainly investigates which predictors (VIX or EPU index) are useful to forecast future volatility for 19 equity indices based on HAR framework during coronavirus pandemic. Out-of-sample analysis shows that the HAR-RV-VIX model exhibits superior forecasting performance for 12 stock markets, while EPU index just can improve forecast accuracy for 5 equity indices, implying that VIX index is more useful for most stock markets' future volatility during coronavirus crisis. The results are robust in recursive window method, alternative realized measures and sub-sample analysis; moreover, VIX index still contains the strongest predictive ability by considering kitchen sink model and mean combination forecast. Furthermore, we further discuss the predictive effect of VIX and EPU index before the coronavirus crisis. Our article provides policy makers, researchers and investors with new insights into exploiting the predictive ability of VIX and EPU index for international stock markets during coronavirus pandemic.     

S&P 500 implied volatility and monetary policy announcements

While many studies have investigated the link between macroeconomic events and equity market volatility, few have considered the impact on option implied volatilities. Given the recent focus on trading in implied volatility, in the context of the S&P 500 VIX index, this paper examines how the VIX index behaves around US monetary policy announcements. It is revealed that the VIX index falls significantly on the day of Federal Open Market Committee meetings.     

Implied volatility and future portfolio returns

Prior studies find that the CBOE volatility index (VIX) predicts returns on stock market indices, suggesting implied volatilities measured by VIX are a risk factor affecting security returns or an indicator of market inefficiency. We extend prior work in three important ways. First, we investigate the relationship between future returns and current implied volatility levels and innovations. Second, we examine portfolios sorted on book-to-market equity, size, and beta. Third, we control for the four Fama and French [Fama, E., French, K., 1993. Common risk factors in the returns on stocks and bonds. Journal of Financial Economics 33, 3–56.] and Carhart [Carhart, M., 1997. On persistence in mutual fund performance. Journal of Finance, 52, 57–82.] factors. We find that VIX-related variables have strong predictive ability.     

Do fear indices help predict stock returns?

This study investigates the forecasting power of implied volatility indices on forward looking returns. Prior studies document that negative innovations to returns are associated with increasing implied volatility of the underlying indices; thus, suggesting a possible relationship between extremely high levels of implied volatility and positive short term returns. We investigate this issue by examining the predictive power of three implied volatility indices, VIX, VXN and VDAX, on the underlying index returns. We extend previous research by also focusing on characterised selected stocks and examine the relationship between implied volatility indices and future returns across different sectors and classified portfolios. Our findings suggest that implied volatility indices are good predictors of 20-days and 60-days forward looking returns and illustrate insignificant predictive power for very short term (1-day and 5-days) returns.     

“Life Expectancy in the Future: A Summary of a Discussion among Experts”, Robert B. Friedland,October 1998

Abstract

In this paper we present an econometric model of implied volatilities of S&;P500 index options. First, we model the dynamics the CBOE VIX index as a proxy for the general level of implied volatilities. We then describe a parametric model of the implied volatility surface for options with a term of up to two years. We show that almost all of the variation in the implied volatility surface can be explained by the VIX index and one or two other uncorrelated factors. Finally, we present a model of the dynamics of these factors.     

Volatility linkage across global equity markets

This paper analyzes the volatility linkage across the U.S., European, German, Japanese, and Swiss equity markets from 1999 to 2009. Both the unconditional and conditional correlations exhibit large fluctuations during the sample period. The results from the VAR analysis show an asymmetric two-way relation between the VIX and other market volatility indices, in which VIX has a larger impact in both the tranquil and crisis times. The structure of the volatility correlation before and during the recent global financial crisis does not show significant changes. In addition, robust test results from realized volatilities confirm the results from implied volatility indices.     

Does implied volatility provide any information beyond that captured in model-based volatility forecasts?

This paper contributes to our understanding of the informational content of implied volatility. Here we examine whether the S&P 500 implied volatility index (VIX) contains any information relevant to future volatility beyond that available from model based volatility forecasts. It is argued that this approach differs from the traditional forecast encompassing approach used in earlier studies. The findings indicate that the VIX index does not contain any such additional information relevant for forecasting volatility.     

Impact of macroeconomic announcements on implied volatility slope of SPX options and VIX

This paper examines the impact of macroeconomic announcements on the high-frequency behavior of the observed implied volatility skew of S&P 500 index options and VIX. We document that macroeconomic announcements affect VIX significantly and slope at a lesser extent. We also find evidence that good and bad announcements significantly and asymmetrically change implied volatility slope and VIX.     

A new approach to measuring riskiness in the equity market: Implications for the risk premium

We introduce a new approach to measuring riskiness in the equity market. We propose option implied and physical measures of riskiness and investigate their performance in predicting future market returns. The predictive regressions indicate a positive and significant relation between time-varying riskiness and expected market returns. The significantly positive link between aggregate riskiness and market risk premium remains intact after controlling for the S&P 500 index option implied volatility (VIX), aggregate idiosyncratic volatility, and a large set of macroeconomic variables. We also provide alternative explanations for the positive relation by showing that aggregate riskiness is higher during economic downturns characterized by high aggregate risk aversion and high expected returns.     

Forecasting global stock market volatilities in an uncertain world

We investigate the predictive relationship between uncertainty and global stock market volatilities from a high-frequency perspective. We show that uncertainty contains information beyond fundamentals (volatility) and strongly affects stock market volatility. Using several crucial uncertainty measures (i.e., uncertainty and implied volatility indices), we prove that the CBOE volatility index (VIX) performs best in point (density) forecasting; the financial stress index (FSI) in directional forecasting. Furthermore, VIX's predictive power improved dramatically after the COVID-19 outbreak, and the VIX-based portfolio strategy enables mean-variance investors to achieve higher returns. There are two empirical properties of VIX: (i) it helps reduce significantly forecast variance rather than bias; and (ii) its forecasts encompass other uncertainty forecasts well. Overall, we highlight the importance of considering uncertainty when exploring the expected stock market volatility.     

Comparing U.S. and European market volatility responses to interest rate policy announcements

We examine the responses of U.S. (VIX) and German (VDAX) implied volatility indices to the announcement of interest rate policy decisions by the Federal Open Market Committee (FOMC) and the European Central Bank (ECB). We present new findings that indicate that VDAX declines on FOMC meeting days, a result that holds for nearly all announcement types. VDAX declines on ECB meeting days in which there is a negative rate surprise, or no surprise, and is unrelated to ECB meeting days otherwise. We confirm prior findings that VIX declines on FOMC meetings days regardless of the content of the meeting, but we also find that VIX is unrelated to ECB announcements. Results from our structural VAR analysis indicate that VIX (VDAX) responses to FOMC decisions are related to risk aversion (uncertainty). Taken collectively, our results indicate a prominent position for the FOMC in determining implied volatility levels worldwide.     

Analysing financial contagion and asymmetric market dependence with volatility indices via copulas

This paper explores the cross-market dependence between five popular equity indices (S&P 500, NASDAQ 100, DAX 30, FTSE 100, and Nikkei 225), and their corresponding volatility indices (VIX, VXN, VDAX, VFTSE, and VXJ). In particular, we propose a dynamic mixed copula approach which is able to capture the time-varying tail dependence coefficient (TDC). The findings indicate the existence of financial contagion and significant asymmetric TDCs for major international equity markets. In some situations, although contagion cannot be clearly detected by stock index movements, it can be captured by dependence between volatility indices. The results imply that contagion is not only reflected in the first moment of index returns, but also the second moment, i.e. the volatility. Results also show that dependence between volatility indices is more easily influenced by financial shocks and reflects the instantaneous information faster than the stock market indices.     

Double-jump diffusion model for VIX: evidence from VVIX

This paper studies the continuous-time dynamics of VIX with stochastic volatility and jumps in VIX and volatility. Built on the general parametric affine model with stochastic volatility and jumps in the logarithm of VIX, we derive a linear relationship between the stochastic volatility factor and the VVIX index. We detect the existence of a co-jump of VIX and VVIX and put forward a double-jump stochastic volatility model for VIX through its joint property with VVIX. Using the VVIX index as a proxy for stochastic volatility, we use the MCMC method to estimate the dynamics of VIX. Comparing nested models of VIX, we show that the jump in VIX and the volatility factor are statistically significant. The jump intensity is also stochastic. We analyse the impact of the jump factor on VIX dynamics.     

The jump component of S&P 500 volatility and the VIX index

Much research has investigated the differences between option implied volatilities and econometric model-based forecasts. Implied volatility is a market determined forecast, in contrast to model-based forecasts that employ some degree of smoothing of past volatility to generate forecasts. Implied volatility has the potential to reflect information that a model-based forecast could not. This paper considers two issues relating to the informational content of the S&P 500 VIX implied volatility index. First, whether it subsumes information on how historical jump activity contributed to the price volatility, followed by whether the VIX reflects any incremental information pertaining to future jump activity relative to model-based forecasts. It is found that the VIX index both subsumes information relating to past jump contributions to total volatility and reflects incremental information pertaining to future jump activity. This issue has not been examined previously and expands our understanding of how option markets form their volatility forecasts.     

Pricing volatility options under stochastic skew with application to the VIX index

In recent years, there has been a remarkable growth of volatility options. In particular, VIX options are among the most actively trading contracts at Chicago Board Options Exchange. These options exhibit upward sloping volatility skew and the shape of the skew is largely independent of the volatility level. To take into account these stylized facts, this article introduces a novel two-factor stochastic volatility model with mean reversion that accounts for stochastic skew consistent with empirical evidence. Importantly, the model is analytically tractable. In this sense, I solve the pricing problem corresponding to standard-start, as well as to forward-start European options through the Fast Fourier Transform. To illustrate the practical performance of the model, I calibrate the model parameters to the quoted prices of European options on the VIX index. The calibration results are fairly good indicating the ability of the model to capture the shape of the implied volatility skew associated with VIX options.     

Asymmetric implied market volatility and terrorist attacks

This paper studies the impact of terrorism on implied volatility in the U.S. financial market via an event study methodology. We decompose the options-based and forward looking VIX index into its negative (VIX⁻) and positive (VIX⁺) components, extracted only from put options and call options, respectively. This decomposition of the VIX index allows us to better investigate the asymmetric impact of terrorist attacks on implied volatility from the puts and calls channels separately. Our study finds evidence of a greater impact of terror detected for the puts channel of VIX, namely VIX⁻. We further show that events that occur within the U.S. appear to impact both VIX and VIX⁻ in a similar way, whereas international terrorist attacks show a greater impact on the puts component, VIX⁻. The calls component, VIX⁺, is found to be mainly detached from terrorist attacks.     

Historic risk and implied volatility

This study extends the volatility prediction literature with (1) new intraday realized volatility measures and (2) various implied volatility indexes for commodities, currencies, and equities. Predicting volatility is important for academics, investors, and regulators. Applications range from forecasting stock and option returns to constructing early warning systems. Using twenty-three Chicago Board Options Exchange VIX indexes, as opposed to the common S&P 100 and S&P 500 equity indexes, we find a bidirectional lead-lag relationship between implied volatility and realized volatility. The lead-lag relationships are more robust and stronger using suggested intraday volatility measures than using the interday volatility measures that are common in the literature.     

News sentiment and the investor fear gauge

This note examines the relationship between aggregate news sentiment and changes in the implied volatility index (VIX). A significant negative contemporaneous relationship between changes in VIX and news sentiment is discovered. The relationship is asymmetric whereby changes in VIX are larger following the release of negative news items.     

VCRIX — A volatility index for crypto-currencies

Public interest, explosive returns, and diversification opportunities gave stimulus to the adoption of traditional financial tools to crypto-currencies. While the CRIX offered the first scientifically-backed proxy to the crypto-market (analogous to S&P 500), measuring the forward-oriented risk in the crypto-currency market posed a challenge of a different kind. Following the intuition of the “fear index” VIX for the American stock market, the VCRIX volatility index was created to capture the investor expectations about the crypto-currency ecosystem. VCRIX is built based on CRIX and offers a forecast based on the Heterogeneous Auto-Regressive (HAR) model. The HAR model was selected as the most suitable out of a horse race of volatility models, with two proxies for implied volatility, namely the 30 days mean annualized volatility and realized volatility. The model was further examined by the simulation of VIX (resulting in a correlation of 78% between the actual VIX and a “VIX” version estimated with the VCRIX technology). Trading strategies confirmed the predictive power of VCRIX and supported the selection of the 30 days means annualized volatility proxy. The best performing trading strategy with the use of VCRIX outperformed the benchmark strategy for 99.8% of the tested period and 164% additional returns. VCRIX provides forecasting functionality and serves as a proxy for the investors’ expectations in the absence of a developed crypto derivatives market. These features provide enhanced decision making capacities for market monitoring, trading strategies, and potentially option pricing.     

Volatility timing,sentiment, and the short-term profitability of VIX-based cross-sectional trading strategies

This paper explores the profitability of simple short-term cross-sectional trading strategies based on the implied volatility index (VIX), often referred to as an “investor fear gauge” in the stock market. These strategies involve holding sentiment-prone stocks when VIX is low and sentiment-immune stocks when VIX is high and generate significantly higher excess returns than the benchmark long–short portfolios that do not condition on VIX. We show that the profitability of our trading strategies is not subsumed by the well-known risk factors or transaction cost adjustments. Our findings are consistent with the theory of delayed arbitrage and the synchronization problem of Abreu and Brunnermeier (2002).