An Analysis of the Volatility Index With the Vector Error Correction Model

An Analysis of the Volatility Index With the Vector Error Correction Model

Hakan Altin
Copyright: © 2022 |Pages: 24
DOI: 10.4018/978-1-6684-5528-9.ch006
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Abstract

The primary objective of this study was to examine the causal relationships between the S&P 500, the Dow Jones Industrial, the NASDAQ Composite, and the VIX indices using the VECM method. The findings demonstrated a strong mutual causal relationship between indices. This relationship strongly indicated that other indices tend to follow the VIX index. The direction of this relationship is most valid for American stock markets. Considering the causal relationships between other country indices and the VIX, it can be said that this relationship will remain weak because the VIX index only represents the American markets. Furthermore, even if the relationships between the VIX index and other country indices are accepted as econometrically correct, the mutual causal relationships found cannot go beyond illusion. A foreign investor should not build a portfolio based solely on the VIX index which reflects future expectations only in the American market. However, a foreign investor can use the VIX index as a great metric in the process of minimizing portfolio risk.
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A Review Of Previous Studies On Vix

Boscaljon et al. (2011) examined the effectiveness of the market volatility index (VIX) provided by the Chicago Board Options Exchange. They suggested that portfolios of value stocks outperform (underperform) portfolios of growth stocks after an increase (decrease) in terms of the VIX index. Thus, individuals can achieve economically significant returns by rebalancing their portfolios based on changes in the VIX index.

Ruan (2018) investigated the effect of market volatility (VIX index) on the stock market of the Chinese Stock Exchange using the stock index data of several countries. The results indicated that the VIX index has a significant impact on the connectivity between stock markets. The main purpose of generating the VIX (market volatility index) index is to reflect the expectations of investors regarding the future of the market.

Kudryavtsev (2017) examined the effect of investors' future volatility expectations, expressed by the VIX index, on daily large stock price variances. The results indicated that both positive and negative stock price movements are associated with simultaneous daily changes in the VIX with opposite indicators. On the days when the VIX value changes in the same direction, there are large stock price changes followed by non-significant price changes.

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