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The Rise and Fall of S&P500 Variance Futures

Volatility is an indispensible component of sensible portfolio risk management. The volatility of an asset of composite index can be traded by using volatility derivatives, such as volatility and variance swaps, options and futures. The most popular volatility index is VIX, which is a key measure of market expectations of volatility, and hence is a key barometer of investor sentiment and market volatility. Investors interpret the VIX cash index as a “fear” index, and of VIX options and VIX futures as derivatives of the “fear” index. VIX is based on S&P500 call and put options over a wide range of strike prices, and hence is not model based. Speculators can trade on volatility risk with VIX derivatives, with views on whether volatility will increase or decrease in the future, while hedgers can use volatility derivatives to avoid exposure to volatility risk. VIX and its options and futures derivatives has been widely analysed in recent years. An alternative volatility derivative to VIX is the S&P500 variance futures, which is an expectation of the variance of the S&P500 cash index. Variance futures are futures contracts written on realized variance, or standardized variance swaps. The S&P500 variance futures are not model based, so the assumptions underlying the index do not seem to have been clearly understood. As these two variance futures are thinly traded, their returns are not easy to model accurately using a variety of risk models. This paper analyses the S&P500 3-month variance futures before, during and after the GFC, as well as for the full data period, for each of three alternative conditional volatility models and three densities, in order to determine whether exposure to risk can be incorporated into a financial portfolio without taking positions on the S&P500 index itself.

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Paper provided by Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico in its series Documentos de Trabajo del ICAE with number 2011-35.

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Length: 40 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:ucm:doicae:1135
Note: The authors are most grateful for the helpful comments and suggestions of participants at the International Conference on Risk Modelling and Management, Madrid, Spain, June 2011. The first author wishes to acknowledge the financial support of the National Science Council, Taiwan, the second and fourth authors acknowledge the Ministerio de Ciencia y Tecnología and Comunidad de Madrid, Spain, and the third author is most grateful for the financial support of the Australian Research Council, Japan Society for the Promotion of Science, and the National Science Council, Taiwan.
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