Tracking the VIX

Abstract

Volatility has emerged as an important and distinct asset class over the past decade. The popularity of volatility stems from its unique properties—namely, its negative correlation with equity returns and its usefulness as insurance against tail risk. Trading applications of volatility-related securities and financial instruments involve, among others, short-term trading to exploit shifts in volatility (realized, implied, or expected implied volatility), hedging an equity exposure, and modifying the risk of an asset allocation mix.

This article examines the tracking performance of VIX futures and seven popular volatility exchange-traded products (ETPs) on the spot VIX index. The empirical findings suggest limited tracking ability of all the products under review because the magnitude of the respective tracking errors is significant. Therefore, even though a plethora of volatility products currently exist, there is still potential room for additional VIX ETP offerings that would attempt to track spot VIX following either a physical or a synthetic replication method.

TOPICS: Analysis of individual factors/risk premia, tail risks, volatility measures