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Diversification of Equity with VIX Futures: Personal Views and Skewness Preference

Carol Alexander () and Dimitris Korovilas
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Dimitris Korovilas: ICMA Centre, Henley Business School, University of Reading

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

Abstract: A comprehensive description of the trading and statistical characteristics of VIX futures and their exchange-traded notes motivates our study of their benefits to equity investors seeking to diversify their exposure. We analyze when diversification into VIX futures is ex-ante optimal for standard mean-variance investors, then extend this to include (a) skewness preference, and (b) a moderation of personal forecasts by equilibrium returns, as in the Black-Litterman framework. An empirical study shows that skewness preference increases the frequency of diversification, but out-of-sample the optimally-diversified portfolios rarely out-perform equity alone, even according to a generalized Sharpe ratio that incorporates skewness preference, except during an extreme crisis period or when the investor has personal access to accurate forecasts of VIX futures returns.

Keywords: Black-Litterman Model; Mean-Variance Criterion; Optimal Asset Allocation; SPY; Roll cost; VIX Futures; VXX; Volatility ETNs (search for similar items in EconPapers)
JEL-codes: G11 G15 G23 (search for similar items in EconPapers)
Date: 2012-03
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