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Modelling the risk–return relation for the S&P 100: The role of VIX

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  • Kanas, Angelos

Abstract

A significantly positive risk–return relation for the S&P 100 market index is detected if the implied volatility index (VIX) is allowed for as an exogenous variable in the conditional variance equation. This result holds for 4 alternative GARCH specifications, irrespective of the conditional distribution, and regardless of whether the conditional mean equation includes a constant term. This finding is robust to sub-samples, and to using VIX innovations to control for dividend yield and trading volume effects. Monte Carlo evidence suggests that if VIX is not included, the risk–return relation is more likely to be negative or weak, in line with several previous studies. If VIX is included, the distribution of the risk–return parameter has more than 99% of its mass in the area of positive values. We conclude that VIX carries important forward-looking information which improves the precision of the conditional variance estimation and, subsequently, reveals a significantly positive relation.

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  • Kanas, Angelos, 2012. "Modelling the risk–return relation for the S&P 100: The role of VIX," Economic Modelling, Elsevier, vol. 29(3), pages 795-809.
    • Handle: RePEc:eee:ecmode:v:29:y:2012:i:3:p:795-809
    DOI: 10.1016/j.econmod.2011.10.010
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    More about this item

    Keywords

    S&P 100; VIX; GARCH-M; Risk–return relation; Monte Carlo;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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