Public and Option-Based Indicators of Financial Tail Risk
Summary
The discussion surveys possible indicators of market tail risk and financial stress. It points to the St. Louis Fed Financial Stress Index as a public measure, mentions sell-side stress indicators, and describes research proposing VVIX—the volatility of VIX options—as a signal related to the pricing and subsequent returns of tail-hedging options. It also references a method for estimating tail risk from option data and a set of financial conditions indices.
The cited VVIX result links higher volatility-of-volatility to more expensive S&P 500 puts and VIX calls, followed by lower returns on those hedges over the next several weeks. The document does not establish one definitive, real-time tail-risk gauge: several measures are proprietary or subjective, and the academic method requires option data. Financial stress indices and option-based signals measure related but distinct conditions, so their usefulness depends on the intended risk and market.
Key ideas
- Public financial stress indices can provide accessible measures of strained market conditions.
- VVIX has been studied as a predictor of returns on tail-hedging options.
- Option-based tail-risk estimation methods require suitable options data.
- No single indicator is presented as a definitive measure of current tail risk.
Tags
Full text
# Where can I find a current tail risk indicator? # Where can I find a current tail risk indicator? The definition of tail risk (risk of 3-standard deviations movement) seems to imply there would be a current market indicator for this. Is there such an indicator available somewhere? ## Answer by AK88 (score 1, accepted) https://quant.stackexchange.com/a/59341 Twitter feed of Taleb is a decent predictor. Other than that, most of the stuff that you find is proprietary and somewhat subjective/vague. Here is a paper that proposes VVIX index as a tail risk indicator: > This paper reports that the volatility-of-volatility implied by VIX options has predictability for tail risk hedging returns. Specifically, an increase in the volatility-of-volatility as measured by the VVIX index raises current prices of tail risk hedging options, such as S&P 500 puts and VIX calls, and lowers their subsequent returns over the next three to four weeks. The results are robust to jump risk, skewness, kurtosis, option liquidity, variance risk premium, and limit of arbitrage. The predictability can be explained by either risk premiums for a time-varying crash risk factor or uncertainty premiums for a time-varying uncertain belief in volatility. ## Answer by user42108 (score 2) https://quant.stackexchange.com/a/59339 St. Louis Fed Financial Stress Index - https://fred.stlouisfed.org/series/STLFSI2 There are others (e.g. from the sellside) but this is publicly available. EDIT: looks like some of the sellside indicators are published on Bloomberg (no permissioning required), e.g. GFSI Index from BAML. ## Answer by Stéphane (score 2) https://quant.stackexchange.com/a/59348 Bollerslev and Todorov have a paper on this: Tails, Fears, and Risk Premia, Jrl of Finance, (December 2011), pages 2165-2211 (link) . If you have option data, you can simply apply their method. Very often, academics publish their codes and their data on their website -- maybe either of them, or someone else who quote them have the codes. ## Answer by Dimitri Vulis (score 0) https://quant.stackexchange.com/a/59351 From https://www0.gsb.columbia.edu/faculty/fmishkin/papers/nberwp.w16150.pdf > We consider seven well-established FCIs: the Bloomberg FCI, the Citi FCI, the Deutsche Bank (DB) FCI, the Goldman Sachs (GS) FCI, the Kansas City Federal Reserve Financial Stress Index (KCFSI), the Macroeconomic Advisers Monetary and Financial Conditions Index, and the OECD FCI.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.