The VIX index: forecasting power and performance in a risk management framework

This paper explores the information content and the forecasting power of the VIX Index, computed by CBOE, on two different levels. First, the expected 30-day volatility implicit in the index level is compared to the realized volatility measurements. Then, VIX is used to compute value-at-risk for a hypothetical portfolio replicating Standard and Poor’s 500 Index and the measure is backtested against actual losses. In both tests, the total period of 20 years (January 1995-December 2014) is split into two sub-periods, precisely before and after March 2006, i.e the introduction of option contracts on the VIX index. The results are not clear-cut. The VIX index shows strong information content, but is an upward biased forecast of realized performance. Its information content seems unaffected by the event of becoming a negotiable asset. When used to compute value-at-risk, however, the measures based on VIX are less effective especially in periods of higher volatility.