Does VIX truly measure return volatility?

K. Victor Chow, Wanjun Jiang, Jingrui Li

Research output: Chapter in Book/Report/Conference proceedingChapterpeer-review

10 Scopus citations

Abstract

This chapter demonstrates theoretically that without imposing any structure on the underlying forcing process, the model-free CBOE volatility index (VIX) does not measure market expectation of volatility but that of a linear moment-combination. Particularly, VIX undervalues (overvalues) volatility when market return is expected to be negatively (positively) skewed. Alternatively, we develop a model-free generalized volatility index (GVIX). With no diffusion assumption, GVIX is formulated directly from the definition of log-return variance, and VIX is a special case of the GVIX. Empirically, VIX generally understates the true volatility, and the estimation errors considerably enlarge during volatile markets. The spread between GVIX and VIX follows a mean-reverting process.

Original languageEnglish
Title of host publicationHandbook of Financial Econometrics, Mathematics, Statistics, and Machine Learning (In 4 Volumes)
Pages1533-1559
Number of pages27
ISBN (Electronic)9789811202391
DOIs
StatePublished - 1 Jan 2020

Keywords

  • Ex ante moments
  • Implied volatility
  • VIX

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