The Secret Life of Fear: Interdependencies Among Implied Volatilities Represented by different Stock Volatility Indices Treated as Assets

Abstract

This study focuses on the systemic interdependencies of specified volatility indices, the underlying assets of which are major stock indices of developed financial markets. The volatility indices in question follow the standard VIX specification, and thus give forward-looking 30-day estimates of implied volatilities on each market respectively. Volatility is then considered as an asset. Engle’s Dynamic Conditional Correlation specification of the VAR-MVEGARCH -methodology is used to study spillovers in volatilities between different markets, as well as dynamic conditional volatility and correlation structures. Additionally, asymmetric behavior of volatilities is taken into account. The time period from January 2000 to mid-June 2009 includes both times of normal market conditions and crises. The results prove unidirectional spillovers from the US VIX to other indices, and more locally from the VFTSE to the VSMI. The dynamic conditional volatilities include abrupt and large short-term peaks, while the dynamic conditional correlations (DCC) are high and stable. The deviations from DCC -means revert back smoothly so that the spillovers between the indices take place over time, and can be interpreted as information transformation. The VDAX and the VFTSE of the main European markets are highly unified, having high correlations but no spillovers between them. All indices contain small but significant volatility asymmetries, and day effects.