Breaking VIX at Open: Evidence of Uncertainty Creation and Resolution

Abstract

We decompose daily (close-to-close) changes of VIX into overnight (close-to-open) and trading-hour (open-to-close) changes. Consistent with the notion that non-trading creates uncertainty and trading resolves uncertainty, we find that there is generally an increase in VIX overnight and decrease in VIX during trading hours. More importantly, we document an important seasonality in VIX, i.e., the non-trading day effect. Overnight increase of VIX involving weekends or holidays is significantly higher than that over two consecutive trading days. We also document that VIX exhibits different patterns around pre-scheduled macroeconomic news announcements, unexpected economic events, and government policy actions. In particular, we observe an increase of VIX prior to pre-scheduled macroeconomic news announcements such as the FOMC announcements, followed by a sharp drop-off post the announcements. Finally, we show that breaking daily VIX changes into overnight and trading-hour components and incorporating the non-trading day effect and the effects of informational events in the modeling of VIX dynamics lead to not only significant improvements in in-sample fitting but also superior performance of out-of-sample-forecasting and active trading strategies on VIX.

Keywords: VIX index; Uncertainty creation; Uncertainty resolution; Macroeconomic news announcements; Out-of-sample forecasts; Trading strategy

JEL Classification: G14; G17