Future portfolio returns and the VIX term structure

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) and VIX-based risk measures, such as the variance risk premium, are predictors for future portfolio returns. In addition to the current level of the squared VIX and its changes over past periods (as previously identified by Banerjee and coworkers), the differential of expectations about future risk as indicated by the difference between long-horizon and short-horizon VIX indexes is another relevant pricing factor. We use the difference between the CBOE Standard & Poor’s 500 six-month and nine-day volatility indexes (the long-minus-short implied volatility measure) to proxy this risk differential. This measure captures how risk is expected to evolve and is thus directly related to the VIX term structure. Including it in a predictive portfolio regression model improves the fit by approximately two basis points in terms of the adjusted R2. The results hold for various portfolio sortings (industry, book-to-market, size) and over different sample periods. Overall, the results support the notion that volatility risk has multiple facets that are priced individually.