Decomposing the VIX Index into Greed and Fear

Juan Andrés Serur, José P. Dapena y Julián R. Siri - UCEMA

Por Juan Andrés Serur, José P. Dapena y Julián R. Siri

Serie de Documentos de Trabajo. Marzo de 2021.

Greed and fear are the main psychological factors driving investment deci-sions, and the VIX Index is regarded as the most important measure of howfearful the market feels about future returns of the main equity index, theS&P 500 Index. However, given that the VIX is calculated by combiningboth upside expected volatility implicit in out-of-the-money calls and down-side expected volatility implicit in the value of out-of-the-money puts, thetaken-for-granted assumption that a rising VIX should be interpreted as asign of growing fear in the equities market can be misleading. In this paperwe formally deconstruct the index into two components, the upside and thedownside expected volatility, in a similar fashion as it is done in statisticswith the semi-variance. We then propose a Greed-Fear index using the dataobtained to provide a better gauge about investors’ sentiment on the market.

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