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Coherent Model-Free Implied Volatility: A Corridor Fix for High-Frequency VIX

Author

Listed:
  • Torben G. Andersen

    (Kellogg School of Management; Northwestern University and CREATES)

  • Oleg Bondarenko

    (Department of Finance (MC 168), University of Illinois at Chicago)

  • Maria T. Gonzalez-Perez

    (Colegio Universitario de Estudios Financieros (CUNEF))

Abstract

The 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.

Suggested Citation

  • Torben G. Andersen & Oleg Bondarenko & Maria T. Gonzalez-Perez, 2011. "Coherent Model-Free Implied Volatility: A Corridor Fix for High-Frequency VIX," CREATES Research Papers 2011-49, Department of Economics and Business Economics, Aarhus University.
    • Handle: RePEc:aah:create:2011-49
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    References listed on IDEAS

    as
    1. Mark Britten‐Jones & Anthony Neuberger, 2000. "Option Prices, Implied Price Processes, and Stochastic Volatility," Journal of Finance, American Finance Association, vol. 55(2), pages 839-866, April.
    2. Todorov, Viktor & Tauchen, George, 2010. "Activity signature functions for high-frequency data analysis," Journal of Econometrics, Elsevier, vol. 154(2), pages 125-138, February.
    3. Torben G. Andersen & Oleg Bondarenko, 2007. "Construction and Interpretation of Model-Free Implied Volatility," NBER Working Papers 13449, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Andersen, Torben G. & Bondarenko, Oleg, 2014. "VPIN and the flash crash," Journal of Financial Markets, Elsevier, vol. 17(C), pages 1-46.
    2. Torben G. Andersen & Nicola Fusari & Viktor Todorov, 2015. "Parametric Inference and Dynamic State Recovery From Option Panels," Econometrica, Econometric Society, vol. 83(3), pages 1081-1145, May.
    3. Christoffersen, Peter & Jacobs, Kris & Chang, Bo Young, 2013. "Forecasting with Option-Implied Information," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 581-656, Elsevier.
    4. repec:esx:essedp:713 is not listed on IDEAS
    5. Takkabutr, Nattapol, 2013. "Option-Implied Risk Aversion Anomalies: Evidence From Japanese Market," Hitotsubashi Journal of Economics, Hitotsubashi University, vol. 54(2), pages 137-157, December.
    6. Konstantinidi, Eirini & Skiadopoulos, George, 2016. "How does the market variance risk premium vary over time? Evidence from S&P 500 variance swap investment returns," Journal of Banking & Finance, Elsevier, vol. 62(C), pages 62-75.
    7. Shan Lu, 2019. "Testing the Predictive Ability of Corridor Implied Volatility Under GARCH Models," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 26(2), pages 129-168, June.
    8. Konstantinidi, Eirini & Skiadopoulos, George, 2016. "How does the market variance risk premium vary over time? Evidence from S&P 500 variance swap investment returns," Journal of Banking & Finance, Elsevier, vol. 62(C), pages 62-75.
    9. Markose, Sheri M & Peng, Yue & Alentorn, Amadeo, 2012. "Forecasting Extreme Volatility of FTSE-100 With Model Free VFTSE, Carr-Wu and Generalized Extreme Value (GEV) Option Implied Volatility Indices," Economics Discussion Papers 3713, University of Essex, Department of Economics.
    10. Barunik, Jozef & Barunikova, Michaela, 2015. "Revisiting the long memory dynamics of implied-realized volatility relation: A new evidence from wavelet band spectrum regression," FinMaP-Working Papers 43, Collaborative EU Project FinMaP - Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents.
    11. Jozef Barunik & Michaela Barunikova, 2012. "Revisiting the fractional cointegrating dynamics of implied-realized volatility relation with wavelet band spectrum regression," Papers 1208.4831, arXiv.org, revised Feb 2013.
    12. Bondarenko, Oleg, 2014. "Variance trading and market price of variance risk," Journal of Econometrics, Elsevier, vol. 180(1), pages 81-97.
    13. Rohini Grover & Ajay Shah, 2014. "The imprecision of volatility indexes," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2014-031, Indira Gandhi Institute of Development Research, Mumbai, India.
    14. Kent Daniel & Ravi Jagannathan & Soohun Kim, 2012. "Tail Risk in Momentum Strategy Returns," NBER Working Papers 18169, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    VIX; Model-Free Implied Volatility; Corridor Implied Volatility; Time Series Coherence;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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