Fund Volatility Index Using Equity Market State Prices

Abstract

The Fund Volatility Index (FVX) is proposed as a forward measure of volatility with applications in fund hedging and risk management. The method applies equity market state prices to individual fund pay-offs. FVX is validated as a predictor of short-term realised volatility for 30 exchange traded funds. Performance of the method is compared with existing methods using a data set of 14 925 non-traded funds. FVX has lower bias and higher forecast accuracy than existing methods. As a more general measure, it allows for incorporation of terms to capture individual fund skewness and projection of higher moments of returns.