Thursday, June 20, 2013

VXEEM as a Measure of Emerging Markets Volatility and Risk

If you think U.S. stocks have been through a rough patch as of late, then you haven’t been paying attention to emerging markets stocks, where the popular EEM emerging markets ETF as fallen from a high of 42.96 on May 22nd to 37.02 earlier today – a 13.8% drop in less than one month. A large part of the problem has been the performance of the BRIC countries, where Brazil (EWZ), China (FXI) and India (EPI) are all acting as if they have been thrown overboard with anchors tied to their ankles, making Russia (RSX) look like the most stable investment of the group – which is quite a task.

Investors looking to monitor risk and uncertainty in Brazil and China are fortunate enough to have dedicated volatility indices based on the VIX methodology for EWZ and FXI. These volatility indices were created by the CBOE and use the tickers VXEWZ and VXFXI, respectively. For a more holistic view of risk and uncertainty in the emerging markets space, the best choice is probably VXEEM, the CBOE Emerging Markets ETF Volatility Index that is calculated based on options in EEM.

The chart below shows the relative performance of VXEEM and the VIX going back to the end of October 2012. Note that during toward the end of 2012, the debate over sequestration caused the markets to assign much more additional risk and uncertainty to U.S. stocks than to emerging markets stocks. During the course of the last month or two, this relationship has reversed and the risk and uncertainty associated with VXEEM has grown at a much faster rate than that of the VIX. On average, the absolute level of VXEEM is about 40% higher than that of the VIX. This week, however, VXEEM has been about 60% higher than the VIX.

On a related note, I find it interesting that S&P announced the launch of the S&P Emerging Markets Volatility Short-Term Futures Index just ten days ago. With that index in place, it would be relatively easy to create a futures-based emerging markets volatility ETP that would function in the same manner as VXX, but be based on VXEEM rather than the VIX. The biggest obstacle to this type of product is probably the current lack of liquidity in the VXEEM futures market.

[source(s): Google Finance]

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Disclosure(s): short VXX at time of writing

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