Diversification of Equity with VIX Futures: Personal Views and Skewness Preference

34 Pages Posted: 24 Mar 2012 Last revised: 19 May 2012

See all articles by Carol Alexander

Carol Alexander

University of Sussex Business School

Dimitris Korovilas

University of Reading - ICMA Centre

Date Written: March 22, 2012

Abstract

A comprehensive description of the trading and statistical characteristics of VIX futures and their exchange-traded notes motivates our study of their benefits to equity investors seeking to diversify their exposure. We analyze when diversification into VIX futures is ex-ante optimal for standard mean-variance investors, then extend this to include skewness preference, and a moderation of personal forecasts by equilibrium returns, as in the Black-Litterman framework. An empirical study shows that skewness preference increases the frequency of diversification, but out-of-sample the optimally-diversified portfolios rarely out-perform equity alone, even according to a generalized Sharpe ratio that incorporates skewness preference, except during an extreme crisis period or when the investor has personal access to accurate forecasts of VIX futures returns.

Keywords: Black–Litterman Model, mean–variance criterion, optimal asset allocation, SPY, roll cost, VIX futures, VXX, volatility ETNs

JEL Classification: G11, G15, G23

Suggested Citation

Alexander, Carol and Korovilas, Dimitris, Diversification of Equity with VIX Futures: Personal Views and Skewness Preference (March 22, 2012). Available at SSRN: https://ssrn.com/abstract=2027580 or http://dx.doi.org/10.2139/ssrn.2027580

Carol Alexander (Contact Author)

University of Sussex Business School ( email )

Falmer, Brighton BN1 9SL
United Kingdom

HOME PAGE: http://www.carolalexander.org

Dimitris Korovilas

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom
+44 (0)118 378 8239 (Phone)
+44 (0)118 931 4741 (Fax)

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