Tracking the VIX Index

Abstract

Volatility has emerged as an important 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 in order 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 paper 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 as the magnitude of the respective tracking errors is significant. Therefore, even though there is a plethora of volatility products nowadays, 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.

Keywords: Exchange Traded Funds, tracking ability, volatility, VIX index, VIX futures

JEL Classification: G19, G23