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FRM Part I · FRM Exam Part I · Measuring Return, Volatility, and Correlation

An analyst compares the VIX with the subsequent realized volatility of S&P 500 returns over many years. Which finding is most consistent with the empirical evidence on the variance risk premium?

VIX is on average above subsequent realized volatility. Investors pay a premium for downside and volatility protection, so option-implied variance typically exceeds later realized variance. This variance risk premium means implied volatility is informative but a biased, upward-skewed forecast of realized volatility.

  1. AVIX is on average below subsequent realized volatility, since option sellers underprice insurance
  2. BVIX is on average above subsequent realized volatility, since investors pay a premium for protection against volatility increasesCorrect
  3. CVIX equals subsequent realized volatility on average, since implied volatility is an unbiased forecast
  4. DVIX has no relationship with subsequent realized volatility

Explanation

Empirically, implied volatility from index options tends to exceed later realized volatility on average, reflecting a premium that investors pay for protection against market declines and volatility spikes. It is still informative about future volatility, so no relationship is wrong, and it is not an unbiased forecast.

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