Is the VIX futures market able to predict the VIX index? A test of the expectation hypothesis

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Abstract

This paper tests the expectation hypothesis by using the volatility index VIX and the futures written on that index. Because the VIX index is negatively correlated with the S&P 500 index returns the VIX futures price should contain a negative risk premium, which we do confirm in this study. When the futures price is not adjusted with the risk premium, the expectation hypothesis is rejected at the 5 percent significance level for 20 of 21 forecast horizons. However when we adjust the futures price with the risk premium, obtained from a stochastic volatility model, the expectation hypothesis cannot be rejected. Further, we find that the risk premium adjusted futures price forecasts the direction of the VIX index well. The one day ahead forecast predicts the direction correctly 73 percent of the time.

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Research areas and keywords

Subject classification (UKÄ) – MANDATORY

  • Economics

Keywords

  • Forcasting, VIX, MCMC
Original languageEnglish
Pages (from-to)54-67
JournalThe Journal of Alternative Investments
Volume12
Issue number2
Publication statusAccepted/In press - 2009
Publication categoryResearch
Peer-reviewedYes