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Volatility Forecast by Volatility Index and Its Use as a Risk Management Tool Under a Value-at-Risk Approach

Yam Wing Siu ()
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Yam Wing Siu: Department of Economics and Finance, Hang Seng Management College, Siu Lek Yuen, Shatin, N.T., Hong Kong

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2018, vol. 21, issue 02, 1-48

Abstract: This paper examines the predicting power of the volatility indexes of VIX and VHSI on the future volatilities (or called realized volatility, σ30,r) of their respective underlying indexes of S&P500 Index, SPX and Hang Seng Index, HSI. It is found that volatilities indexes of VIX and VHSI, on average, are numerically greater than the realized volatilities of SPX and HSI, respectively. Further analysis indicates that realized volatility, if used for pricing options, would, on some occasions, result in greatest losses of 2.21% and 1.91% of the spot price of SPX and HSI, respectively while the greatest profits are 2.56% and 2.93% of the spot price of SPX and HSI, respectively, making it not an ideal benchmark for validating volatility forecasting techniques in relation to option pricing. Hence, a new benchmark (fair volatility, σf) that considers the premium of option and the cost of dynamic hedging the position is proposed accordingly. It reveals that, on average, options priced by volatility indexes contain a risk premium demanded by the option sellers. However, the options could, on some occasions, result in greatest losses of 4.85% and 3.60% of the spot price of SPX and HSI, respectively while the greatest profits are 4.60% and 5.49% of the spot price of SPX and HSI, respectively. Nevertheless, it can still be a valuable tool for risk management. z-values of various significance levels for value-at-risk and conditional value-at-value have been statistically determined for US, Hong Kong, Australia, India, Japan and Korea markets.

Keywords: Implied volatility; value at risk; volatility index; volatility forecasts (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1142/S0219091518500108

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