Does VIX Truly Measure Return Volatility?
Handbook of Financial Econometrics, Mathematics, Statistics, and Machine Learning, Forthcoming
35 Pages Posted: 31 Aug 2014 Last revised: 7 Jul 2020
Date Written: January 22, 2018
This article 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.
Keywords: Implied Volatility, VIX, Ex-ante Moments
JEL Classification: G10
Suggested Citation: Suggested Citation