Since Wall Street's "fear index" spiked in April, even casual investors have watched it nervously for signs of whether to buy, hold,, or run for their lives.
The CBOE Volatility Index , commonly known as the VIX, signals the market's expectations for volatility over the coming 30 days. When the VIX rises, investors expect steeper ups and downs. When it falls, it suggests calmer conditions.
In early April, the VIX did both . It hit 60 — for the first time since the COVID-19 pandemic — after President Donald Trump announced worldwide tariffs. After most tariffs were paused, the index slid to 17 by mid-June.
In new research, Ehud Ronn , professor of finance at Texas McCombs, tests a long-held belief about the VIX: that volatility can be profitable. Over time, the theory goes, the market tends to reward higher levels of systemic risk with higher returns.
Ronn finds that it does, but with some caveats. He offers fresh insights into how the index might factor into investment decisions.
With Liying Xu of Oklahoma Baptist University, Ronn compared VIX levels with subsequent realized returns for the S&P 500. They measured indicators on a daily, weekly, and monthly basis over periods of two, four, five, and 10 years from 2012 to 2022. They found that generally, the higher the VIX, the more robust the ultimate returns.
"We were able to show that subsequent returns were indeed higher," says Ronn. "In other words, if you have the financial and intestinal fortitude to step up to the plate when everyone else is headed out the door, on average you will be rewarded for taking on that risk."
Hold, Don't Sell
The researchers also evaluated a contrary approach proposed by another researcher: lowering equity exposure in times of higher volatility. He proposed that when the VIX rises above 30%, an investor should reduce the percentage of stocks in their portfolios. They should buy back in once volatility dies down.
Ronn and Xu simulated that strategy for 29 historical episodes in which the VIX exceeded 30%. They found that the portfolio underperformed the market. Says Ronn, "The proposed solution is not something that investors should follow."
Instead, he says, the average investor does better to stand pat when stocks fall and the VIX climbs. In his simulation, holding stocks through episodes of high volatility produced a 10.9% higher annualized return than selling and buying back.
"Decide on the fraction of stocks, bonds, and cash you're comfortable holding, and then don't respond to every little twitch in the market," he says.
He has different advice for one group of investors: those with high appetites for risk. "When the VIX is high, invest, because on average you will be compensated," Ronn says.
"But that really does take guts, because you just don't know beforehand when the VIX will peak and the market will trough. If I knew that, I'd be retired in the Riviera right now."
" Is VIX a Contrarian Indicator? On the Positivity of the Conditional Sharpe Ratio " is published inEconometrics.
