VIX Exchange Traded Products: Performance, Price Discovery and Hedging

Abstract

This paper investigates the performance, hedging ability and price discovery relationship between some of the most popular exchange traded products with the volatility index VIX as the underlying. We find a large difference in the price discovery function for the direct unleveraged VIX ETPs. The VIX ETPs have good trackingperformance, but suffer from time-decay due to the shape of the VIX futures termstructure. This time-decay makes them unsuitable for buy-and-hold investments,but gives rise to a profitable trading strategy using direct and inverse VIX ETPs.The strategy is robust to transaction costs. Despite being negatively correlatedwith the S&P 500, the ETPs perform poorly as hedging tools. By using simplerebalancing rules, the inclusion of VIX ETPs in a portfolio tracking the S&P 500will decrease the risk-adjusted performance of the portfolio.