Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for May 2024 (Final)

Momentum Investing Strategy (Strategy Overview)

Allocations for May 2024 (Final)
1st ETF 2nd ETF 3rd ETF

VVIX/VIX as a Return Indicator?

| | Posted in: Volatility Effects

Is the ratio of implied volatility of implied volatility (CBOE VVIX Index), interpretable as a measure of changes in investor fear level, to CBOE VIX Index itself a useful indicator of future stock market returns? To investigate, we relate monthly VVIX/VIX and monthly change in VVIX/VIX to monthly SPDR S&P 500 (SPY) total returns. Using end-of-month levels of both VVIX and VIX and dividend-adjusted monthly SPY closes during January 2007 (limited by VVIX) through July 2021, we find that:

The following chart summarizes lead-lag relationships between monthly VVIX/VIX and monthly change in VVIX/VIX and monthly SPY returns, ranging from SPY leads VVIX/VIX metrics by six months (-6) to VVIX/VIX metrics lead SPY returns by six months (6). Notable points are:

  • SPY returns persistently lead VVIX/VIX by up to six months. In other words, a relatively strong (weak) stock market over the past few months indicates relatively high (low) VVIX/VIX.
  • There may be very weak negative relationships between VVIX/VIX and future SPY returns at two-to-five month horizons, but correlations are likely too small to exploit.
  • There is a strong contemporaneous (0) positive correlation between SPY return and monthly change in VVIX/VIX.
  • Monthly change in VVIX-VIX has a modest positive correlation with next-month SPY return. In other words, a large monthly jump (drop) in VVIX/VIX weakly indicates a relatively strong (weak) SPY return next month. This finding is seemingly at odds with the hypothesized relationship. Correlations at other horizons are very weak.

In case there are important non-linearities in relationships, we look at average SPY returns across ranges of VVIX/VIX metrics.

The next chart summarizes average next-month SPY returns by ranked fifth (quintile) of monthly VVIX/VIX and monthly change in VVIX/VIX. There are only 34-35 observations per quintile. Notable points are:

  • Variations across quintiles are not systematic, undermining belief in reliable relationships.
  • There is no range of VVIX/VIX that precedes a poor average SPY return.
  • The largest monthly drops in VVIX/VIX precede a poor average SPY return, but:
    • Excluding the two worst monthly SPY returns for this quintile flips average SPY return positive.
    • The next-lowest quintile precedes an exceptionally high average SPY return.

In summary, evidence from simple tests on available data offers little support for belief that either VVIX/VIX  or change in VVIX/VIX is useful for timing the U.S. stock market at a monthly horizon.

Cautions regarding findings include:

  • The overall sample period is not long in terms of variety in market environments.
  • Quintile subsamples are small.
  • Testing multiple metrics on the same SPY data introduces data snooping bias, such that the better-performing strategy likely overstates expectations.

See also “VVIX as a Return Indicator?” and “Slope of VVIX Term Structure as Return Predictor”.

Daily Email Updates
Filter Research
  • Research Categories (select one or more)