Construction of VIX index for Indian capital market

Abstract

The VIX has become a popular volatility index to gauge the sentiments of the market participants. The index in US is based on a weighted average of S and P 500 options that straddle a 30-day maturity. The manner of calculating the VIX emerged in September of2003 and has been described in this report. In this report, we have computed the volatility index for Indian capital market (expected volatility of NIFTY Index). The method presented is based on VIX Index (VIX White Paper, 2003). Also, we have compared the new VIX calculation methodology with the old one and discussed the major changes in the new methodology. After calculating the Indian VIX index, we tried to investigate and reason out the difference in the computed VIX index and VIX values published by NSE. We also analyzed VIX as index-based instruments both on construction of minimum risk portfolio. In the report, an analysis has been carried out to evaluate VIX as hedging and trading instrument. The analysis of VIX as hedging instrument has been done for both Indian and US market. Also, few trading strategies have been formulated using the VIX. Historical data has been analyzed and various hypothesis testing approach, like Spearman Rank Coefficient Correlation, have been adopted to test the profitability of the trading strategy. We have analyzed if investing in VIX alone will give better returns compared to the market. The report also discusses few derivative instruments based on VIX and how these instruments can be used for better risk management.