SmartETF

The Volatility Index Family Tree

Unique homework, a capital idea! Thank you for this contribution. Parallel to this is the Family Tree of Risk. The early ETF's mirrored the broad market indices. The next wave was a land grab for sector indices; increasing the risk anywhere from 1.2 to 8.3 times the volatility of the broad markets. Then came the sub-sector ETF’s (example, biotech), inverse funds and leveraged funds; risk for these are in the nose-bleed section. Not until mid-2006 did we see a reversal in risk with the introduction of non-equity based ETF’s such as fixed income, real estate and commodities.

It would be nice to have a volatility index that targets each asset class and sector in each country. We do this using Extreme Value Theory which incorporates fat-tail events (using Stable Distributions) and GARCH to properly weigh the data. Short of this complexity, a basic volatility index would at least demonstrate the general level of volatility.