Friday, February 27, 2015

VIX and uncertainty - there is a difference




The VIX index of option volatility has been often referred to as a market fear index. Some also use this as an uncertainty index. Investors will use these terms interchangeably, but the wording is not precise. The VIX index is the weighted average of option volatility for actual stock prices while market uncertainty may be better represented by the dispersion of opinions across investors. We can use an actual measure of uncertainty with the Economic Policy Uncertainty index which collects information on forecast dispersion and news stories on uncertainty.

If we compare the VIX as a fear index and the economic policy uncertainty index, we can see that they are not always tracking the same thing. Look at the long-run in the top chart and you can see there is a close relationship but there are also clear divergences. Fear came before uncertainty in 2010. In 2013, there was an increase in uncertainty but no fear.

Over the last year we had a spike in the October VIX reading, but no change in uncertainty. In the summer there was an increase in uncertainty but no change in the fear index.

To get an idea of market stress or ambiguity both these measures are useful.

No comments: