Volatility, Risk, and Market Expectations

Jan 22
2 min read

Updated: Jan 23

Volatility has evolved from a simple statistical concept into a cornerstone of modern financial markets. In Volatility, Risk, and Market Expectations, the Bocconi Students Asset Management Club explores how volatility—particularly through the VIX Index—functions not only as a measure of risk, but as a tradable asset class and a forward-looking indicator of market sentiment.

The report begins by clarifying the distinction between realized volatility, which reflects past market fluctuations, and implied volatility, which captures investors’ expectations for future uncertainty. The VIX, derived from S&P 500 option prices, emerges as a powerful barometer of market stress, reacting swiftly to macroeconomic shocks, geopolitical events, and shifts in monetary policy.

Building on this foundation, the authors analyze volatility as an asset class. They examine VIX-linked instruments such as futures, options, and volatility swaps, and explain how the shape of the VIX futures curve—whether in contango or backwardation—signals different market regimes. In particular, the slope of the futures curve is shown to be a leading indicator of transitions between calm and stressed market conditions, with important implications for volatility carry and portfolio hedging strategies.

A central contribution of the paper lies in its quantitative analysis of volatility modeling. The study compares the classic Heston stochastic volatility model with a more complex jump-augmented framework (SVJJ). Using daily market data on VIX futures from 2006 to 2025, the empirical results show that the simpler Heston model performs remarkably well. Despite lacking explicit jumps, its parameters adapt dynamically during periods of market stress, delivering pricing accuracy comparable to more complex models—often at a fraction of the computational cost.

The report then connects theory to practice by outlining common volatility trading and hedging strategies, from straddles and spreads to Greek-based risk management techniques. Volatility is presented not just as insurance against market downturns, but as a potential source of alpha and diversification in modern portfolios.

Finally, the authors offer a forward-looking market outlook. They argue that political uncertainty, interest-rate sensitivity, and rising geopolitical risks are likely to keep both realized and implied volatility elevated in the coming years. Rather than viewing volatility purely as a threat, the report concludes that it should be treated as a strategic component of portfolio construction—one that reflects how markets price uncertainty itself.