# Can VIX be interpreted as a proxy for instantaneous volatility?

Bakshi et al., (2006) Estimation of continuous-time models with an application to equity volatility dynamics (Table 2) estimate the following Cox-Ingersoll-Ross model for market variance, $\sigma^2_t$:

$\mathrm{d}\sigma^2_t = (\alpha_0 + \alpha_1\sigma^2_t)\mathrm{d}t + \sqrt{\beta_1}\sigma_t\mathrm{d}W_t$

To estimate their model they use $\left(\frac{VIX_t}{100}\right)^2$ as a proxy to $\sigma^2_t$, where $VIX_t$ is the daily VIX price.

But VIX measures expected volatility (in percentage terms) of the market over the next 30-day period (as implied by S&P index options). So $\left(\frac{VIX_t}{100}\right)^2$ is basically a moving average over future daily market variance. This extra MA structure makes it a poor proxy to the true instantaneous market variance $\sigma^2_t$---especially when trying to model daily market variance dynamics.

What am I missing? Have I misunderstood something? Or have I understood things correctly and using the $VIX_t$ proxy is considered a "good enough" approach?

NOTE: The authors do end up estimating $(\alpha_0, \alpha_1, \beta_1) = (0.3141, -8.0369, 0.1827)$, which implies a long-run market volatility of 0.20 in annualized terms. That more or less agrees with observations. So maybe "good enough"?

• Hi brianjd, welcome to quant.SE and thanks for posting your question. Oct 3, 2011 at 20:30
• VIX index (or V2X for the Eurostoxx50) cannot be used to estimate the instantaneous volatility. It is rather used for long-period comparison purpose. For example let's consider an article of 2003 of Polson and Stroud. A forecast for the Heston instant volatility is built from stock historic data. Then turning to real data, they compare VIX and the historic instant vol estimator on a 10Y period. The two curves have almost the same behavior. However, on a 1Y comparison one observes an excessive smoothness of the VIX and the lack of interactivity of this index compared to the instant estimator.. Oct 4, 2011 at 13:32
• @Beer4All: Thx for pointing this out. Makes sense if VIX is thought of as a 30-day-MA over future daily volatility Oct 4, 2011 at 22:22
• Here's my 5 cents. VIX does not estimate Local Volatility, for that you can look at Ait-Sahalia + Jacod book named High-Frequency Financial Econometrics. In fact, if you estimate the local volatility (under ito semimartingale price movements) and compare it to the VIX, you get two series with very different behaviors, especially across important news announcements (like the FOMC). In fact, across FOMC announcements the average Local Volatility jumps up, but the average VIX does not change. Feb 15, 2018 at 23:44
• The link to the paper is broke. It would be better if you write out the title and the author of the paper.
– Hans
Mar 22, 2018 at 0:13