| By: |
Torben G. Andersen (Kellogg School of Management; Northwestern University and CREATES);
Oleg Bondarenko (Department of Finance (MC 168), University of Illinois at Chicago);
Maria T. Gonzalez-Perez (Colegio Universitario de Estudios Financieros (CUNEF)) |
| Abstract: |
The VIX index is computed as a weighted average of SPX option prices over a
range of strikes according to specific rules regarding market liquidity. It is
explicitly designed to provide a model-free option-implied volatility measure.
Using tick-by-tick observations on the underlying options, we document a
substantial time variation in the coverage which the stipulated strike range
affords for the distribution of future S&P 500 index prices. This produces
idiosyncratic biases in the measure, distorting the time series properties of
VIX. We introduce a novel “Corridor Implied Volatility” index (CX) computed
from a strike range covering an “economically invariant” proportion of the
future S&P 500 index values. We find the CX measure superior in filtering out
noise and eliminating artificial jumps, thus providing a markedly different
characterization of the high-frequency volatility dynamics. Moreover, the VIX
measure is particularly unreliable during periods of market stress, exactly
when a “fear gauge” is most valuable. |
| Keywords: |
VIX, Model-Free Implied Volatility, Corridor Implied Volatility, Time Series Coherence |
| JEL: |
G13 C58 |
| Date: |
2011–11–30 |
| URL: |
http://d.repec.org/n?u=RePEc:aah:create:2011-49&r=cfn |