Academic journal article Financial Services Review

Market Timing Using the VIX for Style Rotation

Academic journal article Financial Services Review

Market Timing Using the VIX for Style Rotation

Article excerpt


We examine the effectiveness of the market volatility index (VIX) provided by the Chicago Board Options Exchange in timing shifts for style asset allocation. The findings of Copeland and Copeland (1999) suggest portfolios of value stocks outperform (underperform) portfolios of growth stocks following an increase (decrease) in the VIX index. We find some evidence supporting their initial findings using data from 1990 to 2008 that corresponds with the Chicago Board Options Exchange new VIX measurement. However, the results of this study are only statistically significant for longer holding periods of 30 days or more. Thus, for longer holding periods individuals may be able to gain economically significant returns by rebalancing their portfolios between value and growth stocks based on changes in the VIX index. © 2011 Academy of Financial Services. All rights reserved.

Keywords: VIX Asset allocation rebalance

1. Introduction

Irvin and Pontiff (2009) document the impact of increased economy-wide competition on the significant increase over time in the idiosyncratic volatility of firm-level earnings, cash flows, and sales, which in turn, has lead to higher levels of market volatility. This increased market volatility is a concern for investors and financial planners. Traditional asset allocation models built around modern portfolio theory address portfolio efficiency with respect to risk and return. Market turbulence increases the likelihood that investors may forgo investments in equity securities, because of increased risk. However, there is limited empirical research investigating asset allocation with respect to heightened market volatility. Jacquier and Marcus (2001) point out that increased volatility increases the importance of systematic risk because of associated increases in asset correlations. Investors nearing retirement or in the early years of retirement are more sensitive to market volatility as their portfolios may represent a means of maintaining sustainable income during retirement. Making up for losses associated with volatility may be difficult because of an inability to increase savings or reduce living expenses during the retirement years, which presents a special challenge to financial planners as they advise their clients.

Equity style management based on value, growth, and blended assets is a common approach used by financial advisors to help achieve individuals' objectives outlined in investment policy statements. Thus, mutual funds are often designed to help meet the specific needs of individuals who desire a specific mix of value or growtii investments. The unique properties of each investment style may result in different reactions to increased market volatility. We investigate whether investors can benefit from growth versus value investing based on the implied market volatility.

The market volatility index (VLX) index was first introduced by the Chicago Board Options Exchange (CBOE) in 1993 as a measurement of implied volatility based on Standard and Poor's S&P 100 call and put options. The financial media often refer to the VIX index as a "fear index." This suggests that the VIX is an indicator of market sentiment regarding the level of uncertainty in the U.S. equities market. Using the old VIX measurement based on the Standard and Poor's 100 index as a proxy for implied volatility, Copeland and Copeland (1999) find that changes in implied volatility on stock index futures serve as a market-timing signal. In particular, they find that portfolio returns can be enhanced through style rotation between growth and value portfolios based on changes in me VLX index. In particular, tiiey find portfolios of value stocks outperform (underperform) portfolios of growth stocks following an increase (decrease) in the VLX index. The premise behind mese results is that investors switch to value (growth) stocks with increased (decreased) levels of uncertainty. …

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