In two separate posts this week I argued that VIX has no predictive capacity and that it simply tracks the inverse of price. I also asserted that a new paradigm has emerged in the markets according to which equity investment risk is inversely proportional to price. I justified this based on the fact that momentum trading and flocking of hedge funds dominates market activity. In this post I provide solid evidence that proves beyond doubt that VIX is a just a derivative of the inverse of price.
I implemented a function in Amibroker (Charts created with AmiBroker – advanced charting and technical analysis software. http://www.amibroker.com/”) called CORR that calculates the n-period correlation between VIX and another security. I also implemented a function called INVCORR that calculates the n-period correlation between VIX and the inverse of the price of a security. The results are shown below for S&P 500, for a 120-day rolling correlation:
In the daily S&P 500 chart above, the first indicator pane shows VIX and the next pane its 120-day rolling correlation with the index. It may be seen that since the middle of 2005, the correlation ranged from a maximum of -0.71 to a minimum of -0.91 in late 2011. It is currently at -0.795. This shows that the changes in the index close from one day to the next are highly correlated with the changes of the value of VIX from one day to the next. Furthermore, from the chart it may be seen that very high anti-correlation can occur in uptrends but also in downtrends. Thus, this correlation has no predictive capacity whatsoever.
The bottom pane shows that the correlation between the inverse of price and VIX is the mirror image of that between price and VIX. It has ranged from a low of +0.71 to a high of +0.93 and shows, beyond doubt in my opinion, that VIX just tracks the inverse of price for the most part.
So what is VIX good for? Anything else you might think of except for forecasting purposes. There is absolutely no predictive capacity here. If you just use the inverse of price of S&P 500, you maybe better off.