Fed in Print

Abstract

This paper introduces a new model-free approach to measuring the expectation of market variance using VIX derivatives. This approach shows that VIX derivatives carry different information about future variance than S&P 500 (SPX) options, especially during the 2008 financial crisis. I find that the segmentation is associated with frictions such as funding illiquidity, market illiquidity, and asymmetric information. When they are segmented, VIX derivatives contribute more to the variance discovery process than SPX options. These findings imply that VIX derivatives would offer a better estimate of expected variance than SPX options, and that a measure of segmentation may be useful for policymakers as it signals the severity of frictions.

Yang-Ho Park, Variance Disparity and Market Frictions, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2019-059, Aug 2019.

JEL Classification:

G01 - Financial Economics - - General - - - Financial Crises
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal