Variance Disparity and Market Frictions

55 Pages Posted: 30 Sep 2015 Last revised: 9 Aug 2019

See all articles by Yang-Ho Park

Yang-Ho Park

Board of Governors of the Federal Reserve System

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Date Written: July 10, 2019

Abstract

This paper introduces a new model-free approach to measuring the expectation of market variance using VIX derivatives. This approach shows that VIX derivatives carry different information about future variance than S\&P 500 (SPX) options, especially during the 2008 financial crisis. I find that the segmentation is associated with frictions such as funding illiquidity, market illiquidity, and asymmetric information. When they are segmented, VIX derivatives contribute more to the variance discovery process than SPX options. These findings imply that VIX derivatives would offer a better estimate of expected variance than SPX options, and that a measure of segmentation may be useful for policymakers as it signals the severity of frictions.

Keywords: economic uncertainty; illiquidity; asymmetric information; implied variance; VIX derivative

JEL Classification: G01; G13; G14

Suggested Citation

Park, Yang-Ho, Variance Disparity and Market Frictions (July 10, 2019). Journal of Econometrics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2667198 or http://dx.doi.org/10.2139/ssrn.2667198

Yang-Ho Park (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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