VIX-managed portfolios

• Published in: International review of financial analysis 2024-10, Vol.95, p.103353, Article 103353
• Main Author: Božović, Miloš
• Format: Article
• Language: English
• Subjects: Downside variance; Implied volatility; Tail risk; Transaction costs; Volatility timing
• ISSN: 1057-5219; 1873-8079
• DOI: 10.1016/j.irfa.2024.103353

We propose a simple portfolio management strategy that gauges the leverage based on the observed implied volatility index (VIX). The strategy involves taking less risk when the cumulative previous-month VIX is high and more when it is low. We show that the strategy yields more stable weights and thus requires less rebalancing than comparable strategies based on realized volatility. As a result, it produces substantially higher spanning regression alphas when transaction costs are taken into account. We document this for ten equity factors, six classes of mean–variance efficient portfolios and 176 anomaly portfolios. We argue that the superior performance of the VIX-based strategy is driven by its ability to time volatility and tail risk simultaneously, resulting from the forward-looking nature of the information entailed in the index and the higher-order return moments embedded in the implied volatility smile. •Managing portfolios by scaling with implied volatility improves their performance.•The alphas of VIX-managed portfolios survive under realistic transaction costs.•VIX-managed portfolios require the least rebalancing among the tested strategies.•VIX strategies provide a market-based mechanism for timing volatility and tail risk.