On the analysis of time-varying causality between VIX exchange-traded products and VIX futures contracts in high and low volatility regimes

Purpose - The authors analyse the nature of nonlinear long-run causal dynamics between VIX futures and exchange-traded products (ETPs). Design/methodology/approach - Nonlinear long-run causal relations between daily price movements in ETPs and futures are established through a Markov switching vector error correction model (MS-VECM). Findings - The authors observe time variation in causality with the volatility of volatility. In particular, demand pressures for VIX ETNs and futures can change in different regimes. The authors observe two regimes where regime 1 is classified as low-mean low-volatility, while regime 2 is classified as high-mean high-volatility. The convergence to the long-run equilibrium in the low-mean low-volatility regime is faster than the high-mean high-volatility regime. The nature of the time varying lead lag relations demonstrates the opportunities for arbitrage. Originality/value - The linear causal relations between VXX and VIX futures are well established, with leads and lags generally found to be short-lived with arbitrage relations holding. The authors go further to capture the time-varying causal relationships through a Markovian process. The authors establish the nonlinear causal relations between inverse and leveraged products where causal relations are not yet documented.