The Impact of Volatility Derivatives

Thu, Sep 10, 2009 | Jared Woodard

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Paul Dawson and Sotiris K. Staikouras, “The Impact of Volatility Derivatives on S&P 500 Volatility,” Journal of Futures Markets advance online (2009).

This study investigates whether the newly cultivated platform of volatility derivatives has altered the volatility of the underlying S&P500 index. The findings suggest that the onset of the volatility derivatives trading has lowered the volatility of both the cash market volatility and the cash market index, and significantly reduced the impact of shocks to volatility. When big sudden events hit financial markets, however, the volatility of volatility seems to elevate in the U.S. equity market as a result of increased global correlations. Regardless of the period under examination and the estimator employed, long-run volatility persistence is present. The latter drops significantly when the credit crunch period is excluded from the post-event date sample period. The correlation between the broad equity index and the return volatility remains low, which in turn strengthens the role of volatility derivatives to facilitate portfolio diversification. The analysis also shows that volatility is mean reverting, whereas market data support the impact of information
asymmetries on conditional volatility. In the post-event date phase, no asymmetries are found when the recent crisis is not accounted for. Finally, comparisons with other international equity indices, with no volatility derivatives listed, unveil that these indices exhibit higher volatility and slower recovery from shocks than the S&P500 index. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark

Debates about financial innovation have centered on the most exotic – and especially over-the-counter – products, like credit default swaps and mortgage-backed securities. However, many volatility derivatives are exchange-traded and not so incomprehensible, including VIX options and futures as well as variance-linked products. One finding here is that markets without listed volatility derivatives recover more slowly from shocks. Score one for financial innovation?


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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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