Jan 12, 2011

VIX vs Implied volatility in other asset classes

Everyone wants to know what will happen to the VIX in 2011. Goldman Sachs analysts are forecasting the index to be in the 16-20 range (link), and AlphaShares analyst is concerned that investors have become "too comfortable," and is surprised at the current low levels of implied volatility (link).

I wrote about month ago that as VIX was making multi-month low other volatility indexes tied to other asset classes were not at corresponding levels. Yesterday I finally got around to crunch some numbers. What I did is robust linear regression (in log-levels) with VIX as dependent variable vs MOVE index which measures implied volatility in US treasury market, JPMVXYG7 which tracks implied volatility of G7 currencies, and GVZ index that measures implied volatility of GLD ETF. With each regression I get a theoretical level for the VIX that is statistically consistent with other indexes.

All the indexes seem to point out to a higher level for the VIX. Will VIX move higher, or will other indexes come down? I honestly cannot predict that. The analysis that I constructed above is not something I would use for trading, because although volatility usually spills over from one asset class to another, connections between them are weak, and most importantly not directly tradable. And while my trading model is also bullish on VIX, I want to remind everyone (especially myself) about prolonged bear volatility markets in 2004-2006, when every day someone would complain that VIX is too low, statistically, historically, by this measure or that, and it took years for VIX to get above 20!

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