Diversification with VIX Futures and Related ETNs
April 3, 2012 - Strategic Allocation, Volatility Effects
Should investors diversify U.S. equity holdings with S&P 500 volatility index (VIX) futures or exchange-traded notes (ETN) constructed from these futures? In the March 2012 version of their paper entitled “Diversification of Equity with VIX Futures: Personal Views and Skewness Preference”, Carol Alexander and Dimitris Korovilas examine the performance and equity diversification power of VIX futures. They focus on ETNs with one-month constant maturity, available since January 30, 2009 as VXX (iPath S&P 500 VIX Short Term Futures), and five-month constant maturity, available since February 20, 2009 as VXZ (iPath S&P 500 VIX Mid-Term Futures). They extend these proxies back to December 2005 using matched S&P 500 VIX futures constant maturity index series and further back to April 2004 using futures price data and the Standard & Poor’s methodology. They use SPDR S&P 500 (SPY) to represent equity exposure. For diversity in equity market conditions, they consider three subperiods: April 2004 through September 2006 (tranquil); October 2006 through March 2009 (crisis); and, April 2009 through December 2011 (punctuated volatility). When examining VIX futures contract returns, they roll five days prior to maturity to avoid the effect of maturity on final settlement. Using daily data for SPY, VIX futures, VIX futures indexes, VXX and VXZ as available from March 26, 2004 (the inception of VIX futures) through December 2011, they find that: Keep Reading