India Volatility Index (India VIX) and Risk Management in the Indian Stock Market

This study examines the asymmetric relationship between the India Volatility Index (India VIX) 3 and stock market returns, and demonstrates that Nifty returns are negatively related to the changes in the India VIX levels; in the case of high upward movements in the market, the returns on the two indices tend to move independently. When the market takes a sharp downward turn, the relationship is not as significant for higher quantiles. This property of the India VIX makes it ideal as a risk management tool whereby derivative products based on the volatility index can be used for portfolio insurance against bad declines. We also find that the India VIX captures stock market volatility better than traditional measures of volatility, including the ARCH/GARCH class of models. Finally, we test whether changes in the India VIX can be used as a signal for switching portfolios. Our analysis of timing strategy based on changes in the India VIX exhibits that switching to large-cap (mid-cap) portfolios when the India volatility index increases (decreases) by a certain percentage point can be useful in maintaining positive returns on a portfolio. 1 Professor of Finance, Department of Management Studies, Indian Institute of Technology Madras, Chennai, India. Email: [email protected] 2 Postdoctoral Fellow in Finance, Department of Management Studies, Indian Institute of Technology Madras, Chennai, India. Email: [email protected] The views expressed in the paper are those of the author and do not necessarily reflect the opinion of the National Stock Exchange of India Ltd. 3 ―VIX‖ is a trademark of Chicago Board Options Exchange, Incorporated ("CBOE") and Standard & Poor’s has granted a license to NSE, with permission from CBOE, to use such mark in the name of the India VIX and for purposes relating to the India VIX.