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Tracking VIX with VIX Futures: Portfolio Construction and Performance

In: HANDBOOK OF APPLIED INVESTMENT RESEARCH

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  • Tim Leung
  • Brian Ward

Abstract

We study a series of static and dynamic portfolios of Volatility Index (VIX) futures and their effectiveness to track the VIX. We derive each portfolio using optimization methods, and evaluate its tracking performance from both empirical and theoretical perspectives. Among our results, we show that static portfolios of different VIX futures fail to track VIX closely. VIX futures simply do not react quickly enough to movements in the spot VIX. In a discrete-time model, we design and implement a dynamic trading strategy that adjusts daily to optimally track VIX. The model is calibrated to historical data and a simulation study is performed to understand the properties exhibited by the strategy. In addition, compared to the volatility ETN, VXX, we find that our dynamic strategy has a superior tracking performance.

Suggested Citation

  • Tim Leung & Brian Ward, 2020. "Tracking VIX with VIX Futures: Portfolio Construction and Performance," World Scientific Book Chapters, in: John B Guerard & William T Ziemba (ed.), HANDBOOK OF APPLIED INVESTMENT RESEARCH, chapter 21, pages 557-596, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789811222634_0021
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    References listed on IDEAS

    as
    1. Tim Leung & Jiao Li & Xin Li & Zheng Wang, 2016. "Speculative Futures Trading under Mean Reversion," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 23(4), pages 281-304, December.
    2. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
    3. Tim Leung & Xin Li, 2016. "Optimal Mean Reversion Trading:Mathematical Analysis and Practical Applications," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 9839.
    4. Tim Leung & Raphael Yan, 2019. "A stochastic control approach to managed futures portfolios," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 6(01), pages 1-22, March.
    5. Tim Leung & Xin Li, 2016. "Futures Trading Under Mean Reversion," World Scientific Book Chapters, in: Optimal Mean Reversion Trading Mathematical Analysis and Practical Applications, chapter 5, pages 105-127, World Scientific Publishing Co. Pte. Ltd..
    6. Grunbichler, Andreas & Longstaff, Francis A., 1996. "Valuing futures and options on volatility," Journal of Banking & Finance, Elsevier, vol. 20(6), pages 985-1001, July.
    7. Kevin Guo & Tim Leung, 2016. "Understanding the Tracking Errors of Commodity Leveraged ETFs," Papers 1610.09404, arXiv.org.
    8. Mencía, Javier & Sentana, Enrique, 2013. "Valuation of VIX derivatives," Journal of Financial Economics, Elsevier, vol. 108(2), pages 367-391.
    9. Tim Leung & Brian Ward, 2018. "Dynamic Index Tracking and Risk Exposure Control Using Derivatives," Applied Mathematical Finance, Taylor & Francis Journals, vol. 25(2), pages 180-212, March.
    10. Guo, Kevin & Leung, Tim, 2017. "Understanding the non-convergence of agricultural futures via stochastic storage costs and timing options," Journal of Commodity Markets, Elsevier, vol. 6(C), pages 32-49.
    11. Tim Leung & Brian Ward, 2015. "The golden target: analyzing the tracking performance of leveraged gold ETFs," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 32(3), pages 278-297, August.
    12. Tim Leung & Matthew Lorig, 2016. "Optimal static quadratic hedging," Quantitative Finance, Taylor & Francis Journals, vol. 16(9), pages 1341-1355, September.
    13. Tim Leung & Raphael Yan, 2018. "Optimal dynamic pairs trading of futures under a two-factor mean-reverting model," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 5(03), pages 1-23, September.
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    Cited by:

    1. Chen & Jo-Hui & Hussain & Sabbor & Chen & Fu-Ying, 2023. "The Relationship between VIX and Technical Indicator: The Analysis of Shared-Frailty Model," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 13(3), pages 1-5.
    2. Ali Hirsa & Joerg Osterrieder & Branka Hadji Misheva & Wenxin Cao & Yiwen Fu & Hanze Sun & Kin Wai Wong, 2021. "The VIX index under scrutiny of machine learning techniques and neural networks," Papers 2102.02119, arXiv.org.

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    More about this item

    Keywords

    Applied Investments; Financial Forecasting; Portfolio Theory; Investment Strategies; Fundamental and Economic Anomalies; Behaviour of Investors;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G1 - Financial Economics - - General Financial Markets

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