In Search of a Better Volatility

Abstract

We derive an alternative volatility index from options on E-Mini S&P 500 futures and compare it with the VIX to see which index could provide a more efficient measure of volatility and risk. VCME, our alternative volatility measure, and the VIX are very similar in price and trend, are quite efficient at forecasting future volatility in the short-term, but lose their effectiveness over longer periods of time. We do not find any meaningful relationship with volatility and future stock returns. However, we propose that VCME may be more attractive to a financial institution seeking responsive risk measures, while on average generating less deviations from actual volatility at any time frame from 1 to 21 days forward.