Coherent Model-Free Implied Volatility: A Corridor Fix for High-Frequency VIX

Abstract

A number of fundamental questions regarding the equity-index return dynamics are difficult to address due to the latent character of spot volatility. We exploit tick-by-tick option quotes to compute a novel Corridor Implied Volatility,'' or CX, index which may serve as an observable proxy for short-term volatility. Exploiting this index, we obtain striking new empirical findings. In particular, equity-index volatility jumps are common and they are symmetrically distributed and co-jump with the underlying returns. Moreover, the return-volatility asymmetry, or leverage effect, is more pronounced than generally recognized and is in force for both diffusive and jump innovations in volatility. Finally, the CX index performs admirably during turbulent market conditions so it constitutes a useful real-time gauge of market stress.