The magic of an Allaisian appraisal: implied and historical volatility revisited the VIX: once bitten, twice shy?
This paper revisits the relationship between implied volatility (as measured by the VIX) and historical realized volatility, examining whether the VIX systematically overestimates future volatility and what this implies for options pricing and risk management.
Abstract
The VIX, often described as the market’s «fear gauge,» has become one of the most widely followed financial indicators. However, a persistent empirical regularity suggests that the VIX systematically overpredicts realized volatility, raising questions about the informational content of implied volatility measures.
This paper examines this phenomenon through the lens of Allais-style behavioral finance, arguing that the observed bias reflects systematic patterns in investor psychology rather than pure noise. The analysis draws on long-run historical data spanning multiple market cycles and volatility regimes.
Implications
Our findings suggest that traders and risk managers who take the VIX at face value are likely to systematically overestimate forward-looking risk. The paper discusses practical adjustments that can be made to implied volatility estimates to obtain more accurate forecasts of realized volatility.