Monday, August 20, 2012

How Good is the VIX at Forecasting Future Volatility?

UPDATE: There was an error in the way I annualized the VIX in the original post leading to a different conclusion.  The error should have been corrected below.

According to those who believe in efficient markets, market based prices should be reliable indicators of future events.  If the efficient market hypothesis holds true, then the VIX should be a reliable predictor of future stock market volatility.  Is it?

The VIX is supposed to forecast the 30 day future volatility of the S&P 500.  Below is a chart of the VIX against a chart of the actual realized volatility 30 days from the time of measurement of the VIX.  On average, the VIX has expected a slightly more volatile environment than has been realized over the last 8 years.  The average difference between the VIX and actual volatility in this period was about 3.25%.

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