Do stocks drive changes in VIX or does VIX drive changes in stocks?
In financial markets, few relationships are as iconic as the inverse relationship between stock prices and volatility. When stock prices decline, the VIX rises, and when prices rally, the VIX falls. The VIX index typically moves in opposition to the S&P 500 with remarkable regularity.
But which one causes the other? Does the stock market falling make people scared (pushing the VIX up)? Or does people getting scared (VIX going up) make them sell stocks?
The Competing Theories
The academic literature has traditionally offered two primary explanations for the negative correlation between stock returns and volatility:
Theory 1: The Leverage Effect (Black, 1976; Christie, 1982)
When a company's stock price drops, it means the company is now worth less. But their debt stays the same. So suddenly they're more in debt compared to what they're worth. That makes them riskier. Riskier companies causes volatility to rise.
Theory 2: The Volatility Feedback Hypothesis (Campbell & Hentschel, 1992)
If the market suddenly expects things to get volatile, investors want to get paid more for taking that risk. If they want higher returns in the future, that means prices have to be lower today. So: VIX rises causing stocks to drop.
Previous empirical research has yielded mixed results. Some studies support the leverage effect, particularly at longer time horizons, while others find evidence for volatility feedback. Both sound reasonable, right? That’s why many can’t agree on which one was actually happening.
However, two recent academic papers tackle this question reaching conclusions that appear at odds.
Ekow A. Aikins and Alexander Kurov from West Virginia University find strong evidence that stock returns drive changes in implied volatility expectations.
Christine Bangsgaard and Thomas Kokholm from Denmark’s Aarhus University, in contrast, show that in high-volatility regimes, VIX futures often lead SPX futures.
Both Papers Use Futures Contracts
The authors analyzed two key instruments:
E-mini S&P 500 futures (ES) as a proxy for stock market returns
VIX futures (VX) as a proxy for expected implied volatility
Futures contracts offer several advantages over spot indices:
Futures trade almost 24/7, not just during normal stock market hours.
They’re super liquid.
They track the real indices really closely.
You get way more data to work with.
Study 1: Stock Returns Lead (Aikins & Kurov)
The Challenge
One problem is that stocks and the VIX move at the same time. So if you just compare them, you can’t tell which one is actually causing the other as they’re moving together.
The Solution
Markets exhibit predictable activity patterns throughout the day. Some periods are highly active (like the 9:30am market open), while others are very quiet (like 3:00am). Even though stocks and the VIX move together, the fundamental relationship between them should remain constant regardless of whether it’s 3:00am or 9:30am.
By comparing how stocks and the VIX move together during highly active periods versus very quiet periods, the researchers could mathematically isolate the true causal relationship from random market noise.
An analogy helps clarify this approach: Imagine testing whether pressing the gas pedal makes your car accelerate. If you test on both a windy day and a calm day, the wind adds different amounts of random speed variation. However, the gas pedal’s actual effect should be identical on both days. By comparing the two scenarios, you can determine the pedal’s true effect independent of wind interference.
What They Measured
The researchers aimed to estimate two parameters:
Alpha (α): How much do stocks move when the VIX jumps?
Beta (β): How much does the VIX move when stocks jump?
By leveraging the difference between active and quiet trading periods, they could calculate both parameters accurately.
The Results
Beta (β) was substantial: approximately -2.0 to -2.5. When stocks move, the VIX moves significantly in the opposite direction.
Alpha (α) was minimal: approximately -0.05 to -0.10. When the VIX moves, stocks barely react.
In other words, the VIX’s response to S&P 500 shocks is orders of magnitude larger than the reverse. This demonstrates that stocks lead and the VIX follows.
The findings remained consistent when using 5-minute returns instead of 15-minute returns, confirming the robustness of the results.
Study 2: VIX Futures Lead (Bangsgaard & Kokholm)
Bangsgaard and Kokholm used millisecond-stamped data to examine lead-lag relationships between VIX futures and SPX futures. They measure cross-correlations using two metrics:
Lead-Lag Ratio: Captures the overall ratio of the relationship
Lead-Lag Time: Identifies the peak correlation lag
The Results
In low-volatility periods, the two markets show weak connections
In high-volatility periods, strong negative correlation emerges, with VIX futures leading SPX futures by small time intervals.
Relative liquidity drives leadership: when VIX futures are more liquid, their lead strengthens.
Hedging activity (dealers hedging VIX positions with SPX futures) and negative gamma exposure amplify the VIX lead.
The lead time is too brief to generate profitable trading opportunities after accounting for transaction costs.
Reconciling the Findings
At first glance, the papers seem contradictory. Aikins and Kurov find stocks drive volatility, while Bangsgaard and Kokholm find volatility leads with a lag.
The resolution lies in focus:
Aikins & Kurov are saying at the exact same instant, stock shocks dominate.
Bangsgaard & Kokholm are saying in high-vol regimes, volatility expectations adjust faster, perhaps due to hedging mechanics.
Both can coexist. Information may hit stocks first (driving simultaneous volatility response), but factors like dealer hedging or liquidity create tiny VIX leads in stressed markets.
These papers represent important contributions of a decades-old debate. Together, they paint a nuanced picture: stock returns are the fundamental driver, but volatility markets can briefly take the lead.