How Well Does the VIX Predict Volatility?

Traders often refer to the Volatility Index, otherwise known as the $VIX. Yesterday, I tweeted that you can “(t)ake whatever today’s $VIX is. Divide it by 3.46. That’s the market’s view of the 1 stand dev range +/- for the next 30 days.”

This works because the VIX is an annualized number for the market’s view of the S&P 500’s volatility over the next month. The way we get an annualized number down to one month is by taking the square root of 12 which is roughly 3.46.

So how has this worked out? Pretty well. Jake at EconomPicData was kind enough to post this chart. This shows how the S&P 500 has done for the next month compared with one standard deviation bonds as predicted by the market.

If anything, it looks like the VIX has been too conservative. The red line appears to stay within the blue bands more often than 68% of the time.

Posted by on March 8th, 2012 at 11:09 am

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