Publication: A Simple Expected Volatility (SEV) Index: Application to SET50 Index Options
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2009-03-24
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Abstract
In 2003, the Chicago Board Options Exchange (CBOE) made two key enhancements to the volatility index (VIX) methodology based on S&P options. The new VIX methodology seems to be based on a complicated formula to calculate expected
volatility. In this paper, with the use of Thailand’s SET50 Index Options data, we modify the apparently complicated VIX formula to a simple relationship, which has a higher negative correlation between the VIX for Thailand (TVIX) and SET50 Index Options. We show that TVIX provides more accurate forecasts of option prices than the simple expected volatility (SEV) index, but the SEV index outperforms TVIX in forecasting expected volatility. Therefore, the SEV index would seem to be a superior tool as a hedging diversification tool because of the high negative correlation with the volatility index.
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This paper was written while the first author was visiting the Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam, in autumn 2008.
The first author wishes to acknowledge the financial support of the Stock Exchange of Thailand, while the second author wishes to thank the Australian Research Council
for financial support, and the Erasmus School of Economics for their gracious hospitality and excellent working environment.
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