Article based on the Research of Torben Andersen And Oleg Bondarenko
Published by: Kellog Institute
Date: Sep 2080
“Beyond growth and leverage, a key factor in the value of a given stock, and the broader market, is volatility, or the magnitude of variation in prices over time. Especially in today’s uncertainty-ridden market including a major credit crisis and declining dollar, investors pay sizeable premiums to be hedged against increases in volatility, which typically represent bad market conditions. So it is no surprise that there has been growing market and academic interest in equity-index volatility measures. The best-known volatility measure is the volatility index, or VIX, established by the Chicago Board of Options Exchange (CBOE) in 1993. Practitioners and business scholars have established that the VIX, which is based on real-time option market prices for the S&P 500 stock index, correlates significantly with future equity market volatility as well as global risk factors embedded in credit and sovereign debt spreads. Thus the VIX has also become known as the “global fear index”—the higher the VIX, the greater the concern about global markets. In response, multiple public and over-the-counter markets have emerged to enable direct trading of volatility for different assets—using the methodology behind the VIX—rather than more traditional volatility measures based on the Black-Scholes options pricing model.
“The great practical interest in forecasting volatility raises two key questions: How accurate is the VIX as a predictor of actual future return volatility? And, are there more accurate alternative predictors based on option market prices?
“To answer these questions, Torben G. Andersen, professor of finance at Northwestern’s Kellogg School of Management, and co-author Oleg Bondarenko conducted a study of the construction, interpretation, and predictive value of the VIX and several other option-based volatility measures….”
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