Intertemporal relations between the market volatility index and stock index returns

Ghulam Sarwar

Applied Financial Economics, 2012, vol. 22, issue 11, 899-909

Abstract: We examine the intertemporal relationships between Chicago Board Options Exchange (CBOE) market volatility index (VIX) and returns of the S&P 100, 500 and 600 indexes among three subperiods during 1992--2011 to account for structural shifts in VIX and to investigate if the role of VIX as an investor fear gauge and indicator of portfolio insurance price has strengthened in periods of high market anxiety and turbulence. We find a strong negative contemporaneous relation between daily changes (innovations) in VIX and S&P 100, 500 and 600 returns. Our results suggest that the strength of contemporaneous VIX-returns relation depends on the mean and volatility regime of VIX, and that this relation is much stronger when VIX is both high and more volatile. In fact, during 2004--2011, the negative contemporaneous VIX-returns relation was the most dominating and the only significant relation. Our results also indicate a strong asymmetric relation between daily stock market returns and innovations in VIX, suggesting that VIX is more of a gauge of investor fear and portfolio insurance price than investor positive sentiment. The response of VIX to negative changes in market returns was the highest during 2004--2011 when VIX was most volatile. This result is consistent with rising portfolio insurance premiums in periods of high market anxiety and turbulence.

Date: 2012
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DOI: 10.1080/09603107.2011.629980

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