Advertisement

DECISION

, Volume 42, Issue 1, pp 33–55 | Cite as

On asymmetric relationship of India volatility index (India VIX) with stock market return and risk management

  • Abhijeet Chandra
  • M. Thenmozhi
Research Paper

Abstract

This study examines the asymmetric relationship between India volatility index (India VIX) and stock market returns, and demonstrates that Nifty returns are negatively related to the changes in India VIX levels, but in case of high upward movements in the market, the returns on the two indices tend to move independently. When the market takes sharp downward turn, the relationship is not as significant for higher quantiles. This property of India VIX makes it a strong candidate for risk management tool whereby derivative products based on the volatility index can be used as a tool for portfolio insurance against worst declines. We also find that India VIX captures stock market volatility better than traditional measures of volatility including ARCH/GARCH class of models. Finally, we test whether changes in India VIX can be used as a signal for switching portfolios. Our analysis of timing strategy based on change in India VIX exhibits that switching to large-cap (mid-cap) portfolio when India VIX increases (decreases) by a certain percentage point can be useful for maintaining positive returns on a portfolio.

Keywords

India volatility index Stock returns Risk management Trading strategy Portfolio management 

JEL Classification

C12 C15 C21 C53 

Notes

Acknowledgment

The paper is based on a project initiated and sponsored by the National Stock Exchange of India Ltd. (NSE), and the full report has appeared as the NSE Working Paper WP/9/2013 under NSE Working Paper Series. The financial support from the NSE is gratefully acknowledged. We would like to thank Saumitra Bhaduri, P. Krishna Prasanna, Murugappa Murgie Krishnan, and Narend S. for their constructive comments on earlier versions of the paper. We also thank the Editor and anonymous reviewers for their helpful comments. The usual disclaimers apply.

References

  1. Andersen TG, Bollerslev T (1998) Answering the Skeptics: yes, standard volatility models do provide accurate forecasts. Int Econ Rev 39(4):885–905CrossRefGoogle Scholar
  2. Andersen TG, Bollerslev T, Diebold FX, Labys P (2003) Modeling and forecasting realized volatility. Econometrica 71(2):529–626CrossRefGoogle Scholar
  3. Andersen TG, Bollerslev T, Christoffersen PF, Diebold FX (2006) Practical volatility and correction modeling for financial markets risk management. In: Carey M, Schultz R (eds) Risk and financial institutions. University of Chicago Press for NBER, ChicagoGoogle Scholar
  4. Arrow Kenneth (1965) Aspects of the theory of risk banking. Yrjö Jahnssonin Säätiö, HelsinkiGoogle Scholar
  5. Bagchi D (2012) Cross-sectional analysis of emerging market volatility index (India VIX) with portfolio returns. Int J Emerg Mark 7(4):383–396CrossRefGoogle Scholar
  6. Baker M, Wurgler J (2006) Investor sentiment and the cross-section of stock returns. J Financ 61(4):1645–1680CrossRefGoogle Scholar
  7. Banerjee A, Kumar R (2011) Realized volatility and India VIX. WPS No. 688, Indian Institute of Management CalcuttaGoogle Scholar
  8. Basu S (1983) The Relationship between Earnings’ yield, market value, and the return for NYSE common stocks: further evidence. J Financ Econ 12(1):129–156CrossRefGoogle Scholar
  9. Becker R, Clements AE, White S (2006) On the informational efficiency of S&P 500 implied volatility. North Am J Econ Financ 17(2):139–153CrossRefGoogle Scholar
  10. Becker R, Clements AE, McClelland A (2009) The jump component of S&P 500 volatility and the VIX index. J Bank Financ 33(6):1033–1038CrossRefGoogle Scholar
  11. Blair JB, Poon SH, Taylor SJ (2002) Forecasting S&P 100 volatility: the incremental information content of implied volatilities and high frequency index returns. J Econ 105(1):5–26Google Scholar
  12. Brandt M, Kavajecz Kenneth A (2004) Price discovery in the U.S. treasury market: the impact of order flow and liquidity on the yield curve. J Financ 59:2623–2654CrossRefGoogle Scholar
  13. Copeland MM, Copeland TE (1999) Market timing: style and size rotation using the VIX. Financ Anal J 55(2):73–81CrossRefGoogle Scholar
  14. Corrado CJ, Miller TW (2005) The forecast quality of CBOE implied volatility indexes. J Futures Mark 25(4):339–373Google Scholar
  15. Daniel K, Hirshleifer D, Teoh SH (2002) Investor psychology in capital markets: evidence and policy implications. J Monet Econ 49(1):139–209Google Scholar
  16. Dash S, Moran MT (2005) VIX as a companion for hedge fund portfolios. J Altern Invest 8(3):75–80CrossRefGoogle Scholar
  17. De Long JB, Shleifer A, Summers LH, Waldmann RJ (1990) Noise trader risk in financial markets. J Polit Econ 98(4):703–738CrossRefGoogle Scholar
  18. Dowling S, Muthuswamy J (2005). The implied volatility of australian index options, accessed from http://www.ssrn.com/abstract=500165. Accessed 17 Oct 2013
  19. Epstein LG, Zin SE (1989) Substitution, risk aversion, and the temporal behavior of consumption and asset returns: a theoretical framework. Econometrica 57(4):937–969CrossRefGoogle Scholar
  20. Evans MDD, Lyons RK (2008) How is macro news transmitted to exchange rates? J Financ Econ 88(1):26–50CrossRefGoogle Scholar
  21. Fama E (1965) The behavior of stock-market prices. J Bus 38(1):34–105CrossRefGoogle Scholar
  22. Fama E, French K (1992) The cross-section of expected stock returns. J Financ 47(2):427–465CrossRefGoogle Scholar
  23. Flemming J (1998) The quality of market volatility forecasts implied by S&P 100 index option prices. J Empir Financ 5(4):317–345CrossRefGoogle Scholar
  24. Flemming J, Ostdiek B, Whaley R (1995) Predicting stock market volatility: a new measure. J Futures Mark 15(3):265–302CrossRefGoogle Scholar
  25. French K (1980) Stock Returns and the Weekend Effect. J Financ Econ 8:55–69CrossRefGoogle Scholar
  26. French K, Roll R (1986) Stock return variances: the arrival of information and the reaction of traders. J Financ Econ 17(1):5–26CrossRefGoogle Scholar
  27. French K, Schwert GW, Stambaugh R (1987) Expected stock returns and volatility. J Financ Econ 19(1):3–30CrossRefGoogle Scholar
  28. Frijns B, Tallau C, Rad-Tourani A (2010) The information content of implied volatility: evidence from Australia. J Futures Mark 30(2):134–155Google Scholar
  29. Giot P (2005a) Implied volatility indexes and daily value-at-risk models. J Deriv 12(4):54–64CrossRefGoogle Scholar
  30. Giot P (2005b) Relationships between implied volatility indexes and stock index returns. J Portf Manag 31(3):92–100CrossRefGoogle Scholar
  31. Goldstein DG, Taleb NN (2007) We don’t quite know what we are talking about when we talk about volatility. J Portf Manag 33(4):84–86CrossRefGoogle Scholar
  32. Guo H, Whitelaw R (2006) Uncovering the risk-neutral relationship in the stock market. J Financ 61(3):1433–1463CrossRefGoogle Scholar
  33. Jiang GJ, Lo I (2011) Private information flow and price discovery in the US treasury market. Working paper 2011–5, Bank of CanadaGoogle Scholar
  34. Jiang G, Tian Y (2005) Model-free implied volatility and its information content. Rev Financ Stud 18(4):1305–1342CrossRefGoogle Scholar
  35. Kahneman D, Tversky A (1979) Prospect theory: an analysis of decision under risk. Econometrica 47(2):263–292CrossRefGoogle Scholar
  36. Koenker R (2005) Quantile regression. Cambridge University Press, LondonGoogle Scholar
  37. Koenker R, Bassett GJ (1982) Robust tests for heteroscedasticity based on regression quantile. Econometrica 50(1):43–61Google Scholar
  38. Koenker R, Hallock K (2001) Quantile regression. J Econ Perspect 15(4):143–156Google Scholar
  39. Kumar SSS (2012) A first look at the properties of India’s volatility index. Int J Emerg Mark 7(2):160–176CrossRefGoogle Scholar
  40. Kumar MS, Persaud A (2001) Pure contagion and investor shifting risk appetite: analytical issues and empirical evidence. Int Financ 5(3):401–436CrossRefGoogle Scholar
  41. Lee CMC, Shleifer A, Thaler R (1991) Investor sentiment and the closed-end fund puzzle. J Financ 46(1):75–109CrossRefGoogle Scholar
  42. Lu YC, Wei YC, Chang CW (2012) Nonlinear dynamics between the investor fear gauge and market index in the emerging taiwan equity market. Emerg Mark Financ Trade 48(1):171–191CrossRefGoogle Scholar
  43. Maghrebi N, Kim M-S, Nishina K (2007) The KOSPI200 implied volatility index: evidence of regime switches in volatility expectations. Asia-Pacific J Financ Stud 36(2):163–187Google Scholar
  44. McAleer M, Medeiros MC (2008) Realized volatility: a review. Econ Rev 27(1):10–45CrossRefGoogle Scholar
  45. Merton R (1980) On estimating the expected return on the market: an exploratory investigation. J Financ Econ 8(4):323–361CrossRefGoogle Scholar
  46. Misina M (2003). What does risk-appetite index measure? Bank of Canada Working Paper 2003/23Google Scholar
  47. Neal R, Wheatley SM (1998) Do measures of investor sentiment predict Returns? J Financ Quant Anal 33(4):523–547CrossRefGoogle Scholar
  48. NSE (2007) Computation methodology of India VIX, accessed from http://www.nseindia.com/content/vix/India_VIX_comp_meth.pdf. Accessed 3 April 2013
  49. Olsen RA (1998) Behavioral finance and its implications for stock-price volatility. Financ Anal J 54(2):10–18CrossRefGoogle Scholar
  50. Pandey A (2005) Volatility models and their performance in Indian capital markets. Vikalpa 30(2):27–46Google Scholar
  51. Poon SH, Granger C (2003) forecasting financial market volatility: a review. J Econ Lit 41(2):478–539CrossRefGoogle Scholar
  52. Pratt John (1964) Risk aversion in the small and in the large. Econometrica 32(1/2):122–136CrossRefGoogle Scholar
  53. Ross M (1989) Relation of implicit theories to the construction of personal histories. Psychol Rev 96(2):341–357CrossRefGoogle Scholar
  54. Sarwar G (2011) The VIX market volatility index and us stock index returns. J Int Bus Econ 11(4):167–179Google Scholar
  55. Sarwar G (2012) Is VIX an investor fear gauge in BRIC equity markets? J Multinatl Financ Manag 22(3):55–65CrossRefGoogle Scholar
  56. Sharma JL, Mouugoue M, Kamath R (1996) Heteroscedasticity in stock market indicator return data: volume versus GARCH effect. Appl Financ Econ 6(4):337–342Google Scholar
  57. Shefrin H (2007) Beyond greed and fear. Oxford University Press, New YorkGoogle Scholar
  58. Shiller R (1998) Human behavior and the efficiency of the financial system,” NBER Working Paper No. 6375Google Scholar
  59. Simon DP (2003) The nasdaq volatility index during and after the bubble. J Deriv 11(2):9–24CrossRefGoogle Scholar
  60. Siriopoulos C, Fassas A (2012) An investor sentiment barometer: greek volatility index (GRIV). Glob Financ J 23(2):77–93CrossRefGoogle Scholar
  61. Skiadopoulos G (2004) The greek implied volatility index: construction and properties. Appl Financ Econ 14(16):1187–1196CrossRefGoogle Scholar
  62. Szado E (2009) VIX futures and options: a case study of portfolio diversification during the 2008 financial crisis. J Altern Invest 12(2):68–85CrossRefGoogle Scholar
  63. Tarashev N, Tsatsaronis K, Karampatos D (2003) Investors’ attitude towards risk: what can we learn from options? BIS Quart Rev 6:57–66Google Scholar
  64. Ting C (2007) Fear in the Korea stock market. Rev Futures Mark 16(1):106–140Google Scholar
  65. Whaley RE (1993) Derivatives on market volatility: hedging tools long overdue. J Deriv 1(1):71–84CrossRefGoogle Scholar
  66. Whaley RE (2000) The investor fear gauge. J Portf Manag 26(3):12–17CrossRefGoogle Scholar
  67. Whaley RE (2009) Understanding the VIX. J Portf Manag 35(3):98–105CrossRefGoogle Scholar

Copyright information

© Indian Institute of Management Calcutta 2014

Authors and Affiliations

  1. 1.Department of Management Studies (DoMS)Indian Institute of Technology MadrasChennaiIndia

Personalised recommendations