The Distribution of Uncertainty: Evidence from the VIX Options Market

Abstract

Abstract This article investigates the informational content implied in the risk‐neutral distribution of the VIX, a leading barometer of economic uncertainty. We extract the risk‐neutral distribution from VIX option prices over the sample period from 2006 to 2011 using a non‐parametric approach. We analyze the time‐series behavior of the option‐implied moments and assess whether the information implied in the risk‐neutral distribution has predictive power. The risk‐neutral distribution considerably changed shape during the financial crisis. Furthermore, risk‐neutral moments contain useful information with respect to the likelihood of upward jumps in volatility. Consistent with investors disliking high levels of economic uncertainty, we find that the overall shape of the estimated volatility pricing kernel is increasing. For certain periods, there is a puzzling U‐shape. The behavior of the volatility pricing kernel over time reveals that the financial crisis has affected investors’ attitudes towards risk. © 2014 Wiley Periodicals, Inc. Jrl Fut Mark 35:597–624, 2015