Risk and uncertainty in style rotation

Abstract

The Chicago Board Options Exchange (CBOE VIX; volatility) index has been established as a leading indicator of style returns since increases in this “fear index” lead to outperformance of “value” versus “growth” stocks. This study introduces the concept of “uncertainty” as an additional indicator of returns to value, as measured by the CBOE VVIX (“volatility of volatility”). This index is considered to be a proxy for “uncertainty” in the Knightian sense. Increases in expected volatility lead to short-term positive returns to value, while increases in uncertainty lead to negative short-term returns to value. Each of these observations are especially strong during economic downturns and after decreases in the VIX index. Several macroeconomic indicators provide additional incremental infor- mation regarding these phenomena.