Jul 25, 2010

Modeling VIX For Trading

Here is my VIX forecast for the next expiration: 24.80 +/- 5.40 (See my previous posts 1, 2 on the methodology)

But how accurate is it? The model that I developed can predict "local" probabilistic behavior. Sometimes market undergoes a dramatic regime change, like in the autumn of 2008, or this year when VIX went from under 20 in April to 35 and 40 in May. On a side-note news wires reported of sizable losses Goldman Sachs sustained in the 2nd quarter due to short vol exposure.

These kind of events that the model will fail to anticipate. Recently I've been researching economic indicators that could help forecast such extreme shifts. One of indicators that I came across is St Louis Fed Financial Stress Index. STLFSI is a "portmanteau" index that consists of 18 interest, yield, and volatility related indexes. Below is the plot of VIX and rescaled STLSFI weekly data from Dec-1993 to Jul-2010. Unfortunately, Fed publishes the index once a week, with 1 week delay, making it useless as a leading indicator. Still, perhaps it is something to keep an eye on.

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