Category Archives: Risk

On the relationship between the S&P 500 and the CBOE Volatility Index (VIX)

Besides going over the syllabus during the first day of class on Tuesday, August 22, we will also discuss a “real world” example of financial risk. Specifically, we will look at the relationship between short-term stock market volatility (as indicated by the CBOE Volatility Index (VIX)) and returns (as indicated by the SP500 stock market index).

As indicated by this graph from page 25 of next Tuesday’s lecture note, daily percentage changes on closing prices for VIX and the SP500 are strongly negatively correlated. In the graph above, the y-axis variable is the daily return on the SP500, whereas the x-axis variable is the daily return on the VIX. The blue points represent 6,959 daily observations on these two variables, spanning the time period from January 2, 1990 through August 11, 2017. When we fit a regression line through this scatter diagram, we obtain the following equation:

{R_{SP500}} = 0.0005 - 0.1198{R_{VIX}},

where {R_{SP500}} corresponds to the daily return on the SP500 index and {R_{VIX}} corresponds to the daily return on the VIX index. The slope of this line (-0.1318) indicates that on average, daily VIX returns during this time period were inversely related to the daily return on the SP500; i.e., when volatility as measured by VIX went down (up), then the stock market return as indicated by SP500 typically went up (down). Nearly half of the variation in the stock market return during this time period (specifically, 49.5%) can be statistically “explained” by changes in volatility, and the correlation between {R_{SP500}} and {R_{VIX}} comes out to -0.703. While a correlation of -0.703 does not imply that {R_{SP500}} and {R_{VIX}} will always move in opposite directions, it does indicate that this will be the case more often than not. Indeed, closing daily returns on {R_{SP500}} and {R_{VIX}} during this period moved inversely 78% of the time.

You can see how the relationship between the SP500 and VIX evolves prospectively by entering http://finance.yahoo.com/quotes/^GSPC,^VIX into your web browser’s address field.

Markets’ Steady Climb in 2017 Defies Historic Odds

This WSJ article provides helpful historical context concerning stock market volatility and performance.  The lowest daily VIX closing price ever recorded in its 27-1/2 year history was 9.31 on December 22, 1993 (followed by 9.48 the following day – December 23, 1993).   The closing price for VIX of 9.51 on July 14 is the third lowest close on record. The long-run average for VIX comes in at around 20, and the highest close ever recorded was 80.86 on November 20, 2008 (during the throes of the global financial crisis of 2008).

Three major stock-market benchmarks in the U.S., Europe and Asia have avoided pullbacks this year, commonly defined as 5% declines from recent highs.

Is Your Job About To Disappear?

According to this BloombergBusinessWeek article dated June 22, 2017, the best paid, most vulnerable occupations include “… accountants, benefits managers, credit analysts, and various insurance professionals”… (the y axis measures average annual wage for various occupations, and the x axis measures the likelihood of these occupations going away due to automation.

Use this tool to find out if robots are the future of your profession.
bloomberg.com

Index Funds Still Beat ‘Active’ Portfolio Management

Princeton professor Burton Malkiel (author of “A Random Walk Down Wall Street“, now in its 11th edition, and chief investment officer for Wealthfront) explains why indexed investment is by far and away the best strategy for preserving and growing one’s savings.  For a very compelling and more in-depth treatment of this topic, I highly recommend also listening to Barry Ritholtz’s recent interview of Professor Malkiel  @ https://www.bloomberg.com/news/audio/2017-03-31/replay-interview-with-burt-malkiel-masters-in-business-audio.

There is no better way for individuals to invest in the stock market and save for retirement.

The Index Fund featured as one of “50 Things That Made the Modern Economy”

In this week’s installment of “Fifty Things That Made the Modern Economy”, Tim Harford features the index fund. This 9 minute long podcast lays out the history of the development of the index fund in particular and the evolution of so-called of passive portfolio strategies in general. Much of the content of this podcast is sourced from Vanguard founder Jack Bogle’s September 2011 WSJ article entitled “How the Index Fund Was Born” (available at https://www.wsj.com/articles/SB10001424053111904583204576544681577401622). Here’s the description of this podcast:

“Warren Buffett is the world’s most successful investor. In a letter he wrote to his wife, advising her how to invest after he dies, he offers some clear advice: put almost everything into “a very low-cost S&P 500 index fund”. Index funds passively track the market as a whole by buying a little of everything, rather than trying to beat the market with clever stock picks – the kind of clever stock picks that Warren Buffett himself has been making for more than half a century. Index funds now seem completely natural. But as recently as 1976 they didn’t exist. And, as Tim Harford explains, they have become very important indeed – and not only to Mrs Buffett.”

Warren Buffett is one of the world’s great investors. His advice? Invest in an index fund
bbc.co.uk