How rational could VIX investing be?

Abstract

In the aftermath of the credit and banking crises, VIX-based ETNs have gained in popularity among under-diversified market participants since traditional diversification channels became less effective due to increasing correlations. Since then, VIX investing has attracted much heated debate about its controversial diversification benefits for passive buy-and-hold investors. We show that an uninformed utility-maximizing investor, with a feasible level of risk aversion and reasonable portfolio exposure constraints, can use VIX futures to significantly improve his optimal reference portfolio comprised of a monetary asset, equities, corporate and government bonds. We find also that VIX futures provide significant improvement over hedge funds and commodities. Our results show, however, that VIX futures investing may yield significantly lower than expected utility, which leads to disappointment for investors with higher-order moments preferences.