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

Torben Andersen (), Oleg Bondarenko () and Maria T. Gonzalez-Perez ()
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Oleg Bondarenko: Department of Finance (MC 168), University of Illinois at Chicago, Postal: 601 S. Morgan St., Chicago, IL 60607, USA

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

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.

Keywords: VIX; Model-Free Implied Volatility; Corridor Implied Volatility; Time Series Coherence (search for similar items in EconPapers)
JEL-codes: C58 G13 (search for similar items in EconPapers)
Pages: 42
Date: 2011-11-30
New Economics Papers: this item is included in nep-cfn, nep-ets and nep-mst
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