“The VIX Premium” by Ing-Haw Cheng
Tuck School of Business at Dartmouth
The difference between a VIX futures price and the ex ante physical forecast of the VIX, or the VIX premium, predicts ex post returns to investments in VIX futures at monthly, weekly, and daily frequencies, even after the financial crisis. Its dynamics suggest that the VIX premium increases in response to risk shocks with a delay; if anything, it initially falls when risk rises. This helps explain low volatility premiums around crisis episodes, as well as price fluctuations in several markets which have been shown to fluctuate with the VIX, including US corporate credit spreads, sovereign credit spreads, and carry trade returns in foreign currencies. Trading behavior of market participants can help explain this behavior, and trading the VIX premium has been historically profitable.