Please read Part I for the introduction.
Holding-period back-test
In Part I, we ran a quick back-test that would go long the equity index if the VIX was in a certain quintile and saw how the 5th quintile produced the lowest draw-down returns. The index was held only for a day. However, our box-plot of VIX quintile vs. subsequent n-day returns begs us to look at alternate holding periods as well. What would the returns be if we held onto the index beyond a day?
Here is how long-only S&P 500 returns when VIX is in the 5th quintile, across different holding periods looks like:
The problem with this strategy is that when there is a steep fall in the index, the VIX keeps going higher and will be in the 5th quintile for an extended period of time. Have a look at the 2008-2009 segment in this chart:
What happens if we used the change in VIX to time the equity index?
VIX returns deciles
If we bucket VIX returns (percentage change over previous close over n-days, 1000 trailing observations) into deciles and observe the next 5, 10, 15 and 20-day returns of the underlying index over them:
There is no determinable pattern here. Perhaps the VIX and the index are co-incident with none holding the power of prediction over the other.
Interested readers can browse the github repo for corresponding Nikkei 225 and NIFTY 50 charts.
Comments are closed, but trackbacks and pingbacks are open.