VIX ETPs as Portfolio Diversifiers

Abstract: This paper studies whether the popularity of VIX ETPs can be explained by their suitability as portfolio diversifiers for retail investors having access to a typical set of ETFs. We first carry out an analysis from the perspective of investors with a quadratic utility function by employing the mean-variance spanning test and the mean-variance criterion. We then include skewness and kurtosis in the portfolio selection problem by applying the Lai (1991) polynomial goal programming model. We find that mean-variance investors seeking the global minimum-variance portfolio would have benefitted from adding volatility exposure to their portfolio, while the results are less promising for investors maximising the Sharpe Ratio. Investor preferences for higher moments, especially for skewness, are found to drive substantial allocations to volatility. The findings apply to different market conditions and therefore offer an alternative explanation for the undiminished investor interest in VIX ETPs. They are also robust for different investment intervals.