In this chapter, we looked at volatility derivatives and their uses by investors to diversify and hedge their risk in equity and credit portfolios. Since long-term investors in equity funds are exposed to downside risk, volatility can be used as a hedge for the tail risk and in replacement for the put options. In the United States, the CBOE Volatility Index (VIX) measures the short-term volatility implied by S&P 500 stock index option prices. In Europe, the VSTOXX market index is based on the market prices of a basket of OESX and measures the implied market volatility over the next 30 days on the EURO STOXX 50 Index. Many people around the world use the VIX as a popular measurement tool for the stock market volatility over the next 30-day period. To help us better understand how the VSTOXX market index is calculated, we looked at its components and at formulas used in determining its value.

The STOXX and Eurex Exchange websites provide the historical daily data of the main index...