Sunday, May 16, 2010

VIX Index: AN IMPORTANT PART OF GOOD RISK MODULES

The Chicago Board of Options Exchange (CBOE) publishes an important indicator - the VIX Index - and it does so on a daily basis. The VIX Index measures the implied volatility in the market. Basically: higher levels of VIX indicate that the market is very nervous, whereas... low levels indicate that the market is more or less not jumpy at all. Almost as if investor's don't really seem to care about risk.

CBOE's VIX Index: Usefool Tool for Investors
Including those that focus on Emerging Markets

Very often extremely high VIX scores can easily be interpreted as excess nervousness when thinking about longer-term return implications, although it is dangerous to buy risky investments in that type of climate and expect anything good out of it in the short term.

Very low values of VIX can be OK in the short term, but in the longer term the buyer should be aware of the fact that markets will sooner or later move back to normal. And this move back to normal - read: higher - volatility levels does normally imply lower returns as well. Investors are normally 'warned' that they are underpricing risk through some kind of negative event. Positive events are possible but more rare.

VIX plays an important role in the Risk Module of the LMG Emerge Global Tactical Asset Allocation system, where we look at both the level of VIX and its trend.

We recommend the reader to take a look at the CBOE website and download the data series (VIX new method of calculation). Data are available on a daily basis, starting from 1990. By linking it to return series of financial securities you can derive some interesting conclusions that might be used in an investment strategy.

And although the VIX is an American index, our research has indicated that it can help you with improved analyses for international equities and bonds as well, including Emerging Markets. This is not illogical, because the US market is still trend setting and US investors are the biggest. Looking at market values of equity, the US market does still represent more than 30 percent of the world market value.

Click here for a link to the CBOE website with VIX download facility

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