VIX AND VIX FUTURES: A TOOL OF RISK REDUCTION AND DOWNSIDE PROTECTION FOR HEDGE FUNDS

Abstract

We analyze VIX, VIX futures and hedge funds. VIX is a measure of the implied volatility of S&P 500 index options. VIX futures performance is measured by the S&P 500 VIX Mid-Term Futures Index and the CBOE VIX Premium Strategy Index. Credit Suisse Hedge Fund Index and Hedge Fund Research Indices represent hedge funds performance. In our project, we expand Dash and Moran (2005) by expanding the end period of survey from December 2004 to May 2014 and including two hedge fund databases, Credit Suisse and Hedge Fund Research. In addition, we conduct analyses on both VIX index and VIX futures indices, which are not included in the Dash and Moran (2005). Not only we check the addition of VIX index or VIX futures indices to hedge fund portfolios for risk reduction or downside protection, but also our analysis pays more attention to the period of 2008 financial crisis. We find that broad-based hedge fund indices and most narrow hedge fund indices are negatively and asymmetrically correlated with VIX. Addition of VIX index as well as VIX futures indices protects hedge fund portfolios from major drawdowns and helps reduce risk