In 2003, the Chicago Board Options Exchange (CBOE) made two key enhancements
to the volatility index (VIX) methodology based on S&P options. The new VIX
methodology seems to be based on a complicated formula to calculate expected
volatility. In this paper, with the use of Thailand's SET50 Index Options data,
we modify the apparently complicated VIX formula to a simple relationship, which
has a higher negative correlation between the VIX for Thailand (TVIX) and SET50
Index Options. We show that TVIX provides more accurate forecasts of option prices
than the simple expected volatility (SEV) index, but the SEV index outperforms
TVIX in forecasting expected volatility. Therefore, the SEV index would seem to be a
superior tool as a hedging diversification tool because of the high negative correlation
with the volatility index.
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