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Can the VIX be used as a market timing signal?


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Can the VIX be used as a "buy" or "sell" signal for stock market returns?

Published in: Economy & Finance, Business
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Can the VIX be used as a market timing signal?

  1. 1. Is VIX a good “buy” or “sell” signal for getting in and out of the Market? Gaetan Lion August 16, 2011 1
  2. 2. Looking at monthly data from January 1990 to July 2011 The table above shows that the correlation between the VIX level in one month has near zero correlation with the S&P 500 return over the next month, over next 3 months, and over next 6 months. The graph demonstrates that the relationship between the VIX in one month and the S&P 500 return in the next month is random. 2
  3. 3. How about looking at daily data(January 3, 2000 – August 12, 2011)The above correlations are between the VIX and the S&P 500over a number of trading days forward ranging from 1 to 40trading days. Again, correlations are all close to zero. 3
  4. 4. VIX vs Next Trading Day return Picture of near perfect randomness. 4
  5. 5. VIX vs return in 10 Trading Days Still random. 5
  6. 6. VIX vs return in 20 Trading Days Still random 6
  7. 7. VIX vs return in 40 Trading Days Still random. 7
  8. 8. Trying a VIX@40 as a “Sell” signal VIX @40 sell signalAs shown above the VIX @ 40 sell signal would have completely missed theentire bubble burst. It pretty much kicked in near the bottom of thatmarket cycle. This same sell signal appeared to have missed at least half of theFinancial crisis Bear Market in 2007 – 2008. 8
  9. 9. A closer look at the Financial CrisisLooking at the data from 11/05/2007 to 11/05/2009, we can see that the VIX sellsignal did kick in after the fact. The Bear market was nearly a year old. The VIXpassed the 40 threshold level a full two weeks after the Lehman Brothersbankruptcy (929/2008 vs 9/15/2008). By that time, you did not need the VIX to 9tell you we were already in a market downturn that started 10 months earlier.
  10. 10. Conclusion: the VIX does not work as a market signal• Whether you look at monthly data or daily data, it does not make a difference. Whether you look at different time horizon going forward, it does not make a difference. In all cases, you get a picture of near perfect randomness between the VIX level and prospective market returns.• Even attempting a VIX sell signal @40 (a common threshold considered pretty high and bearish) does not work well.• The VIX is not a leading indicator. It appears to be a lagging indicator that most probably would have far higher negative correlations with past returns vs future returns when correlations were invariably close to zero. 10