Determinants of intraday price discovery in VIX exchange traded notes

• DOI: http://doi.org/10.1002/fut.21907
• Author: Alireza Tourani‐Rad,Bart Frijns,Adrian Fernandez‐Perez,Ilnara Gafiatullina
• Date: 01 May 2018
• Published date: 01 May 2018

Received: 15 September 2017

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Accepted: 31 December 2017

DOI: 10.1002/fut.21907

RESEARCH ARTICLE

Determinants of intraday price discovery in VIX exchange

traded notes

Adrian Fernandez-Perez

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Bart Frijns

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Ilnara Gafiatullina

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Alireza Tourani-Rad

Department of Finance, Auckland

University of Technology, Auckland,

New Zealand

Correspondence

Adrian Fernandez-Perez, Department of

Finance, Auckland University of

Technology, Private Bag 92006, 1142

Auckland, New Zealand.

Email: adrian.fernandez@aut.ac.nz

This study investigates the intraday price discovery of the VIX short-term futures

ETN (VXX) and inverse VIX short-term ETN (XIV) for the period January 3, 2012 to

December 31, 2015. Using Hasbrouck's (1995) Information Share and Lien and

Shrestha's (2014) Generalized Information Share, we document strong time variation

in the contribution to price discovery of the direct and inverse notes. We find that

trading costs and market liquidity are significant determinants of price discovery. We

further document that the informational leadership of the XIV increases on days when

the VIX increases and on days with negative stock market returns.

KEYWORDS

high-frequency data, price discovery, volatility ETNs

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INTRODUCTION

With the introduction of VIX derivatives in 2004, volatility, for the first time, became a tradable product. However, it was not

until the introduction of VIX Exchange Traded Notes (ETNs) that trading in volatility really took off. These products, first issued

in 2009, have gained huge popularity among market participants, with currently 19 VIX related ETPs.

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Volatility ETNs allow

market participants to take direct, inverse, or leveraged positions in S&P 500 volatility. Some ETPs monitor the curvature of the

VIX futures term structure and offer direct or inverse exposures to short- or medium-term futures contracts on the VIX. The most

popular direct ETN is the iPath S&P 500 VIX Short-Term Futures ETN (VXX) and the most popular inverse ETN is the

VelocityShares Daily Inverse VIX Short Term ETN (XIV). Despite the VXX losing about 99% of its value and undergoing four

reverse splits since inception, this ETN remains extremely popular, with an average trading daily volume of 60 mln contracts by

the end of 2016. The XIV, on the other hand, has gained more than 100% since inception and, by the end of 2016, had an average

daily trading volume of close to 30 mln contracts.

The demand for the VXX can be due to either diversification benefits or speculation on future volatility changes. Changes in

the VIX are negatively correlated with changes in the S&P 500. Thus adding volatility exposure to a portfolio can potentially be a

risk mitigation strategy during market turmoil (Signori, Briere, & Burgues, 2010). However, several studies document that VIX

ETNs do not provide an effective hedge when held as a passive buy-and-hold investment.

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As a result, when used as a portfolio

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An exchange-traded product (ETP) is a derivative security which is traded on an exchange. ETPs are typically benchmarked to indices, stocks,

commodities, or may be actively managed. There are several different types of ETPs, including Exchange-traded funds (ETFs) and Exchange-traded notes

(ETNs).

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The long-term performances of VIX ETNs versus the VIX show substantial deviations primarily due to the negative roll-over costs during contango

markets, which is called “contango trap”(Alexander & Korovilas, 2012a; Whaley, 2009).

J Futures Markets. 2018;38:535–548. wileyonlinelibrary.com/journal/fut © 2018 Wiley Periodicals, Inc.

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