Is the VIX Futures Market Able to Predict the VIX Index? A Test of the Expectation Hypothesis

Abstract

This article tests the expectation hypothesis by using the volatility index VIX and futures contracts written on that index. Because the VIX index is negatively correlated with the S&P 500 index returns the VIX futures price should contain a negative risk premium, which is confirmed in this study. When the futures price is not adjusted with the risk premium, the expectation hypothesis is rejected at the 5% significance level for 20 of 21 forecast horizons. However when the futures price is adjusted with the risk premium, obtained from a stochastic volatility model, the expectation hypothesis cannot be rejected. Further, the results show that the risk premium adjusted futures price forecasts the direction of the VIX index well. The one day ahead forecast predicts the direction correctly 73% of the time.