Characteristic Patterns of VIX
VIX has been calculated since 1990, covering a period in which financial markets not only passed through several bull and bear cycles but were impacted by three major financial crises. The history of VIX throughout these events may provide useful background information for trading VIX contracts.

The preceding charts show that VIX jumps, it clusters, it reverts to the mean, and it varies within a trading range. These are all the patterns inherited from realized volatility. In addition, the mean and volatility of VIX change over time following regime shifts in realized volatility, and these shifts are reflected in shifts of the entire frequency distribution of VIX. Another VIX pattern that could prove interesting to futures traders is a slight monthly seasonality, with lower than average values from May to July and higher than average values from September to November.


Relationship between VIX and Other Assets

VIX and the S&P 500
VIX moves inversely to the S&P 500, and more significantly when the S&P 500 declines, which is why it is called the fear gauge. In fact, this inverse correlation has become stronger since 1990. From 1990 to 2004, daily returns of VIX and the S&P 500 had a correlation of .56 for down S&P 500 moves and .40 for up moves. Over the same period, a 1% decrease of the S&P 500 was accompanied by a 4.26% average increase in VIX while a 1% increase of the S&P 500 was accompanied by a 2.30% decrease in VIX.

VIX and Other Asset Classes
With the exception of real estate, the volatility of VIX is significantly higher than the volatility of other assets, and its mean is also higher. This is shown in the graph below which shows the means and standard deviations of monthly returns of VIX, the S&P 500, the Salomon Barney Treasury Bond Index (SBGOV) and Corporate Bond Index (SBBIG), the Dow Jones AIG Commodity Index and the S&P REIT index from January 1990 to December 2004. (the S&P REIT Index starts in 1997, and the Dow Jones AIG Commodity Index in 1991). With the exception of equities, there is no consistently significant correlation between VIX and other asset classes.

VIX and Realized Volatility
VIX should be related to both future and past realized volatility, to the first because VIX reflects the market's forecast of future volatility, and to the second because volatility tends to persist, and its recent level is therefore weighed heavily in that forecast. Consistent with these expectations, the correlation between VIX and volatility realized in the previous month is 0.85 and the correlation between VIX and volatility realized over the next month is 0.75. The mean-reverting tendency of VIX causes it to increase at a decreasing rate with volatility realized over the preceding month.

A perennial question is how well VIX predicts future volatility. This question is difficult to answer conclusively because VIX is not a pure forecast, it is the price of volatility and as such includes a risk premium which probably varies over time⁹ . A measure of how well VIX predicts future volatility is the correlation between actual and expected changes in monthly volatility. Using the difference between VIX and volatility in the previous month as a proxy for the expected change, this correlation is 0.44.