Volatility Exchange-Traded Notes: Curse or Cure?

Posted: 20 May 2012

See all articles by Carol Alexander

Carol Alexander

University of Sussex Business School; Peking University HSBC Business School

Dimitris Korovilas

University of Reading - ICMA Centre

Date Written: May 19, 2012


This paper investigates the trading, hedging and performance characteristics of VIX futures exchange-traded notes (ETNs) and discusses their pros and cons from the perspectives of the regulator, the issuer, and the non-speculative investor. Is this direct trading of volatility in very high volumes a major new source of issuer risk and systemic risk? Or – as advertised by the issuers – do these notes provide a unique source of diversification that should be welcomed by investors and regulators alike? To answer these questions we replicate the ETNs daily indicative values from March 2004 – March 2012, showing that the amplitude and frequency of volatility cycles have indeed increased markedly since the introduction of VIX futures ETNs. On the other hand, we explain how long-term investors can build simple ETN portfolios with uniquely attractive performance and diversification characteristics – provided they hold inverse rather than direct short-term tracker ETNs. Then we focus on the ETN issuers’ hedging activities, where the terms and conditions of early redemption provide transparent front-running opportunities for speculators which in turn increases both the hedging error and the volatility of VIX futures. Furthermore the one-day notice period for early redemption presents a moral hazard problem for the issuer.

Keywords: Exchange-traded notes, constant-maturity VIX futures, roll yield, manipulation-proof performance measure

JEL Classification: G11, G15, G21

Suggested Citation

Alexander, Carol and Korovilas, Dimitris, Volatility Exchange-Traded Notes: Curse or Cure? (May 19, 2012). Available at SSRN: https://ssrn.com/abstract=2062854 or http://dx.doi.org/10.2139/ssrn.2062854

Carol Alexander (Contact Author)

University of Sussex Business School ( email )

Falmer, Brighton BN1 9SL
United Kingdom

HOME PAGE: http://www.coalexander.com

Peking University HSBC Business School ( email )

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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