Coherent Model-Free Implied Volatility: A Corridor Fix for High-Frequency VIX
AbstractThe 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.
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Bibliographic InfoPaper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2011-49.
Date of creation: 30 Nov 2011
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Web page: http://www.econ.au.dk/afn/
VIX; Model-Free Implied Volatility; Corridor Implied Volatility; Time Series Coherence;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-01-03 (All new papers)
- NEP-CFN-2012-01-03 (Corporate Finance)
- NEP-ETS-2012-01-03 (Econometric Time Series)
- NEP-MST-2012-01-03 (Market Microstructure)
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- Todorov, Viktor & Tauchen, George, 2010. "Activity signature functions for high-frequency data analysis," Journal of Econometrics, Elsevier, vol. 154(2), pages 125-138, February.
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