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Review of Financial Economics
journal homepage: www.elsevier.com/locate/rfe
Is gold the best hedge and a safe haven under changing stock market volatility?
Matthew Hood ^{a} ^{,} ^{1} , Farooq Malik ^{b} ^{,} ⁎
^{a} McCoy College of Business Administration, Texas State University, San Marcos, TX 78666, USA
^{b} College of Business, Zayed University, P. O. Box 19282, Dubai, United Arab Emirates
article info
Article history:
Received 16 December 2011 Accepted 26 February 2013 Available online 14 March 2013
JEL classi ﬁcation:
G1
Keywords:
Hedging
GARCH
Volatility
Gold
Safe haven
Volatility shifts
abstract
We evaluate the role of gold and other precious metals relative to volatility (Volatility Index (VIX)) as a hedge (negatively correlated with stocks) and safe haven (negatively correlated with stocks in extreme stock market declines) using data from the US stock market. Using daily data from November 1995 to November 2010, we ﬁnd that gold, unlike other precious metals, serves as a hedge and a weak safe haven for US stock market. However, we ﬁnd that VIX serves as a very strong hedge and a strong safe haven during our sample period. We also ﬁnd that in periods of extremely low or high volatility, gold does not have a negative correlation with the US stock market. Our results show that VIX is a superior hedging tool and serves as a better safe haven than gold during our sample period. We highlight the practical signiﬁcance of our results for ﬁnancial market participants by conducting a port folio analysis.
© 2013 Elsevier Inc. All rights reserved.
1. Introduction
In recent years stock markets around the globe have experienced high volatility and unexpected declining returns. A key question is which investment vehicles serve as a hedge (negatively correlated with stocks) or safe haven (negatively correlated with stocks in extreme stock market declines) in different periods of stock market volatility. Our paper attempts to answer this important question. We start with gold as a leading candidate since it receives widespread attention in the ﬁnancial news. Jaffe (1989) shows that the addition of gold to various hypothetical portfolios increases the average return while reducing the standard deviation. Hillier, Draper, and Faff (2006) note that the major beneﬁt of precious metals is shown to be their ability to hedge adverse market conditions because precious metals perform best during periods of high market volatility. However, the ﬁrst study which formally tests if gold is a hedge or safe heaven was done by Baur and Lucey (2010). They ﬁnd that gold is a hedge against stocks on average and a safe haven in extreme stock market conditions using daily data from 1995 to 2005. Another study on this speciﬁc topic was by Baur and McDermott (2010), who examine the role of gold in the global ﬁnancial system by testing the hypothesis that gold represents a safe haven against stocks of major emerging and developed countries. Using data from 1979 to 2009, they show that gold is both a hedge and a safe haven for the US and major European stock markets but not for emerging stock markets.
⁎ Corresponding author. Tel.: +971 4 4021545; fax: +971 4 4021010. Email addresses: mh91@txstate.edu (M. Hood), farooq.malik@zu.ac.ae (F. Malik). ^{1} Tel.: +1 512 2453195.
10583300/$ – see front matter © 2013 Elsevier Inc. All rights reserved.
There is widespread evidence suggesting that volatility in stock markets is asymmetric implying that returns and conditional volatility are negatively correlated. Seminal paper by Christie (1982) documents and explains this asymmetry based on the leverage hypothesis. He argues that a drop in the value of the stock (negative return) increases the ﬁnancial leverage making the stock riskier thus increasing the under lying volatility. These “leverage effects” have become synonymous with asymmetric volatility although this asymmetric response could be gener ated by the volatility feedback effect driven by time varying risk premium as documented by Campbell and Hentschel (1992). They contend that news brings higher current volatility and thus increases future volatility since volatility is highly persistent. This higher volatility raises the re quired return resulting in a stock price decline. It is now widely believed that none of these effects by itself explain the total asymmetry in equity markets and in reality both effects are in play simultaneously as shown by Bekaert and Wu (2000). Malik (2011) shows that the negative rela tionship is even stronger than previously reported. The remarkably strong negative correlation between volatility and equity prices during market downturns offers a timely protection against the risk of a potential capital loss. ^{2} Based on the reported empirical evidence, we incorporate volatility into our analysis to see if it serves as a hedge and/or safe haven. A study by Briere, Burgues, and Signori (2010) shows that a long exposure to volatil ity is very valuable for diversifying an equity portfolio, especially during equity market downturns. However, to the best of our knowledge, this is the ﬁrst paper to make a direct comparison between gold and volatility
^{2} Whaley, the creator of VIX, even suggests that part of the purpose of VIX is to serve as a hedge to stock investing ( Whaley, 2009 )
48 
M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47 –52 
Table 1 

Descriptive statistics. 
S&P 500 
Gold 
Silver 
Platinum 
VIX 

Arithmetic mean Geometric mean Annualized geometric mean Standard deviation Skewness Kurtosis Minimum Median Maximum Correlation 
0.03% 
0.04% 
0.06% 
0.05% 
0.20% 
0.02% 
0.03% 
0.04% 
0.04% 
0.02% 

4.53% 
8.84% 
11.90% 
9.68% 
4.80% 

1.31% 
1.09% 
1.84% 
1.48% 
6.16% 

0.00 
0.32 
− 0.77 
− 0.19 
1.02 

10.59 
11.13 
12.44 
8.28 
8.79 

− 9.03% 
− 6.98% 
− 18.44% 
− 9.22% 
− 29.57% 

0.06% 
0.02% 
0.10% 
0.04% 
− 0.33% 

11.58% 
10.79% 
14.07% 
10.56% 
64.22% 

100.00% 
− 1.83% 
9.99% 
11.61% 
− 74.08% 
Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30, 2010. The correlation for each asset is its correlation with the S&P 500. The annual geometric mean for
each asset is its effective annual rate of return over the entire sample period.
as a potential hedge or safe haven. This information will be particularly useful to ﬁnancial market participants since volatility is readily tradable, with Volatility Index (VIX) on the Chicago Board Options Exchange (CBOE) being the most prominent derivative. ^{3} Conover et al. (2009) suggest that investors could considerably improve portfolio performance by adding a signiﬁcant exposure to the equities of precious metals ﬁrms. Riley (2010) shows that precious metals have advantages like good expected returns and strong negative correla tions with other asset classes. Additionally, studies like Hammoudeh, Malik, and McAleer (2011) have highlighted the importance of other precious metals besides gold in risk management. Given the growing relevance of other precious metals, we also include silver and platinum in our analysis to see how they compare with gold as a potential hedge or safe haven. The econometric approach in this paper is based on a regression model in which asset returns (gold, silver, platinum, or volatility) are regressed on stock returns and interaction terms that test whether the particular asset indeed serves as a hedge or safe haven if the stock market declines. We use daily data from November 1995 to November 2010. Our sample period is particularly pertinent as it includes the recent ﬁnancial crises. A key feature of equity returns is that volatility is time varying and undergoes shifts in variance [See Starica and Granger (2005)]. Conse quently, we also extend the literature by studying how these different assets correlate with the stock market within the endogenously deter mined volatility regimes. Our results show that platinum and silver do not serve as a hedge or safe haven for the US stock market but gold serves both of these func tions. Interestingly, VIX serves as a stronger hedge and a better safe haven than gold during our sample period. We also ﬁnd that gold does not have a negative correlation with the US stock market in extremely low volatility periods or in extremely high volatility periods, but VIX maintains a negative correlation at all times. Our results suggest that VIX is a superior hedging tool and serves as a better safe haven than gold during our sample period. ^{4}
2. Deﬁnitions
Following Baur and McDermott (2010), we deﬁne a hedge and a safe haven as follows:
^{3} Exposures to volatility can be made by investing in VIX futures contract or an Ex change Traded Fund (ETF) on VIX. On the other hand, investment in gold can be made through a variety of investments. An investor can buy gold coins, gold jewelry, gold bullion, gold ETF or gold futures. There are more alternatives to invest in gold and some of them offer investments without a counterparty (futures exchange or ETF provider) involved with potentially strong implications for a safe haven asset.
^{4} Our results make a timely contribution as during the writing of this manuscript ﬁ nancial markets across the globe are experiencing unprecedented volatility and declin ing returns mainly due to economic problems emanating from Europe.
2.1. Hedge
A strong (weak) hedge is deﬁned as an asset that is negatively corre
lated (uncorrelated) with another asset on average. However, it has to be noted that a hedge does not necessarily have the property of reducing losses in periods of extremely declining markets as the asset could exhibit a positive correlation in such periods and a negative correlation in normal times which could result in a negative correlation on average.
2.2. Safe haven
A strong (weak) safe haven is deﬁned as an asset that is negatively
correlated (uncorrelated) with the stock market in periods of extreme stock market declines. The speciﬁc property of a safe haven asset is the nonpositive correla tion with the stock market in extreme market conditions. However, note that this property does not force the correlation to be positive or negative
on average but only to be zero or negative in speciﬁc periods of stock market declines.
3. Data analysis
The data consist of daily closing spot prices for gold, silver, platinum, the S&P 500 Index, and VIX. All the data used in the paper was obtained from Bloomberg. The data covers from November 30, 1995 to November 30, 2010. Our sample period is particularly interesting since it includes the ﬁnancial crisis of 2008–09. All precious metals are traded at
Fig. 1. Movement in levels of the S&P 500, gold and VIX. Notes: The ﬁgure shows the level of the S&P 500 index, VIX and the price of gold for the 15 year sample period from November 1995 to November 2010 (daily data). The S&P 500 index and price of gold are measured on left vertical axis while VIX is measured on right vertical axis.
M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47 –52
49
Table 2 Asset behavior in declining stock markets.
Quantiles 

0.10 
0.05 
0.01 

S&P 500 
− 2.36% 
− 3.06% 
− 5.10% 
Gold 
0.11% 
0.12% 
0.56% 
Silver 
− 0.28% 
− 0.53% 
− 0.45% 
Platinum 
− 0.23% 
− 0.44% 
− 0.60% 
VIX 
9.95% 
11.68% 
17.54% 
Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30, 2010. The table shows the average returns of each asset only for the worst 10%, 5%, and 1% days for the S&P 500.
COMEX in New York and their prices are measured in US dollars per troy ounce. Within the family of volatility indices, the CBOE VIX is widely used as a benchmark by investors. VIX expresses the 30day implied volatility generated from S&P 500 traded options and thus VIX represents a con sensus view of shortterm volatility in the equity market. The exact time (Eastern Time) of closing price for gold, silver and platinum is 1:30 pm, 1:25 pm and 1:05 pm, respectively, while S&P 500 Index and the VIX closing value occurs at 4 pm. Although our use of the nonsynchronous metal return daily data with the S&P 500 is consistent with the literature but we should point out that it biases against the hedging potential of the metal indices versus the VIX. Table 1 provides descriptive statistics for all ﬁve series under study. Among the precious metals and VIX, VIX has the highest arithmetic mean on a daily basis but its annual geometric mean, which shows the annual rate of return for the whole sample period, is the lowest. This low return is not surprising as volatility (VIX) has a mean reverting behavior. Among the precious metals, we see that silver has the highest standard deviation while gold has the lowest. The standard deviation for VIX is more than three times greater than any of the precious metals. Gold exhibits positive skewness while silver and platinum exhibit nega tive skewness. All ﬁve series show high values of kurtosis, implying that a GARCHtype model is appropriate. The last row of Table 1 documents the correlation of each series with the S&P 500. Gold is the only precious metal which is negatively correlated with the S&P 500. However, the negative correlation of gold is trivial relative to VIX, which is strongly negatively correlated with the S&P 500. Fig. 1 plots the levels of the S&P 500, VIX, and gold over the whole sample period. A careful review of the plot reveals the negative relationship between VIX and the S&P 500 especially during 2008. Another key question in this study is how the precious metals and VIX behave in conjunction with the S&P 500 on its worst performing days. Panel A of Table 2 shows the average daily returns on the worst 1%, 5%, and 10% days for the S&P 500. We see that on the worst 1% days of the S&P 500 it yields an average daily return of − 5.10%. ^{5} On these days, gold and VIX yield a positive return of 0.56% and 17.54%, respectively – both are positive but the return for VIX is substantially greater than for gold. On the worst days of the S&P 500, platinum and silver tend to move in the same direction, which mitigates their effec tiveness as a hedge. Overall, we ﬁnd that gold and VIX have negative re lationship with the stock market when the stock market is declining, but in order to ﬁnd if that relationship is statistically signiﬁcant, we pro ceed to our econometric model.
4. Econometric model
In this section, we present the econometric model which we use to analyze the safe haven and hedge property of different assets relative to the overall stock market. We assume that the price of the asset in each case is dependent on changes in the stock market and further assume that the relationship is not constant but is in ﬂuenced by
^{5} This is the average of the days ’ returns that are in the ﬁ rst percentile, it is not the ﬁrst percentile – which will be shown in Table 5 .
Table 3 Hedge and safe haven assessment.
Hedge 
Safe haven quantiles 

0.10 
0.05 
0.01 

Gold 
− 0.032** 
− 0.070* 
− 0.029 
− 0.202 
Silver 
0.000 
0.011 
0.084 
0.027 
Platinum 
0.099*** 
0.024 
0.105** 
0.217** 
VIX 
− 3.303*** 
− 4.534*** 
− 4.015*** 
− 3.595*** 
Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30, 2010. The estimation results for the role of gold, silver, platinum, and VIX as a hedge and safe haven asset for daily stock market returns. Negative coef ﬁcients in the Hedge column indicate that the asset is a hedge against stocks. Zero (negative) coef ﬁ cients in extreme market conditions [quantile columns (0.10, 0.05, and 0.01)] indicate that the asset is a weak (strong) safe haven. *, **, and *** represents statistical signi ﬁ
cance at the 10% level, 5% level, and 1% level, respectively.
extreme market conditions. We use the regression model proposed by Baur and McDermott (2010) which is given as:
^{R} asset ; t ^{¼} ^{a} ^{þ} ^{b} t ^{R} stock;t ^{þ} ^{ε} t
b _{t} ¼ c _{0} þ c _{1} D ð R
q
stock 10
Þþ c _{2} D ð R
h _{t} ¼ ω þ αε ^{2} _{−}_{1} þ β h _{t} _{−}_{1}
t
q
stock 5
Þþ c _{3} D ðÞ
R
q
stock 1
^{ð}^{1}^{Þ}
ð2Þ
ð3Þ
Eq. (1) models the relationship between each asset (gold, silver, plat inum, or VIX) and the stock returns. The parameters to estimate are a and b _{t} . The error term is given by ε _{t} . The parameter b _{t} is modeled as given by Eq. (2) and the parameters to estimate are c _{0} , c _{1} , c _{2} , and c _{3} . The dummy variables denoted as D(…) capture extreme stock market declines and are equal to one if the stock market crosses a certain threshold given by the tenth, ﬁfth, and ﬁrst percentiles of the return distribution of the
stock market. If one of the parameters c _{1} , c _{2} , or c _{3} is signiﬁcantly different from zero, then there is evidence of a relationship between the particular asset and the stock market. If the parameters in Eq. (2) are negative and statistically different from zero, the asset serves as a strong safe haven. However, if the parameters are nonpositive, then the asset would be a weak safe haven. The asset would serve as a hedge if the parameter c _{0}
is zero (weak hedge) or negative (strong hedge) and the sum of the
parameters c _{1} to c _{3} are not jointly positive exceeding the value of c _{0} . Finally, Eq. (3) presents a GARCH(1,1) model which is used to account for heteroscedasticity in the time series data. All equations are simulta neously estimated using Maximum Likelihood methods.
5. Empirical results
In this section, we present the results from the model estimated above. Table 3 shows the estimates of a regression model given by Eqs. (1), (2), and (3) . The table contains the estimates of c _{0} and the
total effects for extreme market conditions, which is the sum of c _{0} and c _{1} for the tenth percentile; the sum of c _{0} , c _{1} , and c _{2} for the ﬁfth percentile; and the sum of all four coefﬁcient estimates ( c _{0} , c _{1} , c _{2} , and c _{3} ) for the ﬁrst percentile. Looking at the hedge column, we ﬁnd that both gold and VIX serve as
a strong hedge because they have a statistically signiﬁcant negative correlation with the S&P 500. However, looking at the corresponding coefﬁcients, we ﬁnd that VIX has a far bigger coefﬁcient (in absolute value) than gold which implies that it is a far more effective hedge than gold. Silver on the other hand is not correlated with the S&P 500 while platinum has a signiﬁcant positive correlation which implies that
it not a hedge but comoves with the overall stock market.
Table 3 also shows which assets are weak or strong safe havens and which provide no safe haven at all. We ﬁ nd that gold is a strong safe haven at the 10% signiﬁcance level. Speciﬁ cally, we ﬁnd that on the worst days of the US stock market, gold correlates negatively with the S&P 500. Neither silver nor platinum are safe havens.
50
M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47 –52
Table 4 Relationship between VIX and precious metals with the S&P 500 in different volatility regimes.
Starting date 
11/30/95 
11/30/95 
07/29/98 
06/14/02 
10/17/02 
04/02/03 
07/25/03 
07/09/07 
09/12/08 
12/02/08 
06/01/09 
Ending date 
11/30/10 
07/29/98 
06/14/02 
10/17/02 
04/02/03 
07/25/03 
07/09/07 
09/12/08 
12/02/08 
06/01/09 
11/30/10 
All 
1 
2 
3 
4 
5 
6 
7 
8 
9 
10 

Means 

S&P 500 
0.03% 
0.10% 
0.00% 
− 0.16% 
0.01% 
0.18% 
0.05% 
− 0.06% 
− 0.65% 
0.12% 
0.07% 
Gold 
0.04% 
− 0.04% 
0.01% 
− 0.01% 
0.06% 
0.10% 
0.07% 
0.05% 
0.10% 
0.21% 
0.10% 
Silver 
0.06% 
0.03% 
− 0.01% 
− 0.11% 
0.02% 
0.18% 
0.11% 
− 0.04% 
− 0.09% 
0.46% 
0.17% 
Platinum 
0.05% 
0.00% 
0.05% 
0.09% 
0.06% 
0.12% 
0.07% 
− 0.02% 
− 0.55% 
0.34% 
0.10% 
VIX 
0.20% 
0.27% 
0.17% 
0.64% 
− 0.10% 
− 0.47% 
0.14% 
0.43% 
2.61% 
− 0.52% 
0.17% 
Standard deviations 

S&P 500 
1.31% 
0.93% 
1.33% 
2.26% 
1.42% 
1.05% 
0.68% 
1.32% 
4.69% 
2.36% 
1.14% 
Gold 
1.09% 
0.66% 
0.94% 
0.89% 
1.10% 
1.04% 
1.11% 
1.39% 
3.11% 
1.55% 
1.05% 
Silver 
1.84% 
1.57% 
1.18% 
1.02% 
1.08% 
1.08% 
2.07% 
2.20% 
5.32% 
2.36% 
1.94% 
Platinum 
1.48% 
1.18% 
1.58% 
1.13% 
1.14% 
1.31% 
1.19% 
1.84% 
4.13% 
1.83% 
1.36% 
VIX 
6.16% 
5.67% 
5.83% 
6.71% 
4.62% 
3.50% 
5.84% 
7.37% 
12.57% 
5.98% 
6.87% 
Correlations with the S&P 500 

Gold 
− 1.83% 
− 7.93% 
− 9.37% 
− 38.90% 
− 44.76% 
− 33.14% 
10.97% 
− 4.04% 
7.78% 
− 7.70% 
29.84% 
Silver 
9.99% 
− 3.94% 
− 4.35% 
− 28.72% 
− 30.62% 
− 8.44% 
11.59% 
5.27% 
28.06% 
14.81% 
49.51% 
Platinum 
11.61% 
3.19% 
− 0.51% 
7.80% 
− 1.36% 
4.46% 
7.10% 
5.88% 
25.93% 
16.73% 
55.04% 
VIX 
− 74.08% 
− 67.82% 
− 80.72% 
− 85.80% 
− 71.52% 
− 49.53% 
− 77.98% 
− 85.67% 
− 87.46% 
− 78.52% 
− 80.66% 
Notes: The sample period is from November 1995 to November 2010. The time periods of volatility regimes were estimated using ICSS algorithm.
However, we see that VIX is a strong safe haven in the case of extreme negative market shocks at all levels and the correlations are highly signiﬁcant. Thus the relationship of VIX to the stock market is much stronger than it is for gold. In the next section, we explore the rela tionship of different assets with the overall stock market under differ ent stock market volatility regimes.
6. Evaluating correlations under changing stock market volatility
Several studies have documented a change in correlations between markets over time. Solnik, Boucrelle and Fur (1996) document the in crease in correlations over time (1982 to 1995) and especially during more volatile periods. Several other studies have examined the asym metric increase in correlations during declining markets. For example,
Fig. 2. Performance for portfolios of gold and VIX with the S&P 500 from November 1995 to November 2010. Notes: The red line shows a portfolio comprising of different combinations of gold and S&P 500 while the blue line shows a portfolio comprising of different combinations of VIX and S&P 500. The starting point of both lines shows a portfolio with 100% S&P 500. The ﬁgure shows that adding gold or VIX to S&P 500 in creases mean (return) while decreasing standard deviation (risk), and the beneﬁ t of adding VIX is more substantial than adding gold.
Erb, Harvey, and Viskanta (1994) show that the correlations among the Group 7 countries are higher during recessions than during economic growth periods and Longin and Solnik (2001) show that the correlation between markets increases during bear markets and this correlation is related to the market trend. It is also widely documented that markets experience periods where volatility suddenly increases or decreases [See Starica and Granger (2005)]. Consequently, in this section we explore the correlations between different assets with the overall stock market in different volatility periods. In order to detect the relevant volatility periods or
Table 5 Portfolio behavior in declining stock markets.
0% 
5% 
10% 
15% 

Portfolio weight in gold First percentile Second percentile Third percentile Fourth percentile Fifth percentile Sixth percentile Seventh percentile Eighth percentile 
− 3.46% 
− 3.29% 
− 3.14% 
− 2.93% 

− 2.86% 
− 2.70% 
− 2.57% 
− 2.41% 

− 2.44% 
− 2.33% 
− 2.20% 
− 2.06% 

− 2.21% 
− 2.11% 
− 1.98% 
− 1.87% 

− 1.98% 
− 1.90% 
− 1.82% 
− 1.74% 

− 1.83% 
− 1.73% 
− 1.64% 
− 1.57% 

− 1.71% 
− 1.62% 
− 1.53% 
− 1.47% 

− 1.59% 
− 1.52% 
− 1.45% 
− 1.38% 

Ninth 
percentile 
− 1.50% 
− 1.43% 
− 1.37% 
− 1.29% 
Tenth 
percentile 
− 1.41% 
− 1.35% 
− 1.29% 
− 1.22% 
Portfolio weight in VIX First percentile Second percentile Third percentile Fourth percentile Fifth percentile Sixth percentile Seventh percentile Eighth percentile 
− 3.46% 
− 2.73% 
− 2.17% 
− 1.83% 

− 2.86% 
− 2.16% 
− 1.67% 
− 1.45% 

− 2.44% 
− 1.88% 
− 1.39% 
− 1.18% 

− 2.21% 
− 1.65% 
− 1.24% 
− 1.04% 

− 1.98% 
− 1.50% 
− 1.12% 
− 0.96% 

− 1.83% 
− 1.36% 
− 1.04% 
− 0.90% 

− 1.71% 
− 1.27% 
− 0.96% 
− 0.83% 

− 1.59% 
− 1.19% 
− 0.89% 
− 0.78% 

− 1.50% 
− 1.10% 
− 0.81% 
− 0.74% 

− 1.41% 
− 1.03% 
− 0.77% 
− 0.71% 

Ninth percentile Tenth percentile 
Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30, 2010. Portfolios are created with an allocation into gold or VIX with the remainder in the S&P 500. The table illustrates the worst performances over the 15 year period for
the portfolios.
M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47 –52
51
Fig. 3. Portfolio performance with 0%, 5%, 10%, and 15% invested in VIX (with the rest in the S&P 500) on the worst 10% of days from November 1995 to November 2010. Notes: The lowest ten percentiles for a portfolio that is completely invested in the S&P 500 are shown with X’s. The dashed line shows the improvement from a 5% stake in VIX, the circles shows the improvement from a 10% stake, and ﬁnally the solid line shows the improvement with
a 15% stake in VIX.
regimes, we use the Iterative Cumulative Sums of Squares (ICSS) algo rithm given by Inclan and Tiao (1994). This is an endogenous method to detect structural breaks or shifts in variance (volatility) and this method has been widely used in the literature. Details of the ICSS methodology can be found in application papers like Aggarwal, Inclan, and Leal (1999) and Ewing and Malik (2005) among others. ^{6} The ICSS algorithm detects 10 volatility regimes in the volatility of S&P 500 returns during our sample period. The results are documented in Table 4. One can clearly see the highest volatility regime corresponds with the recent ﬁnancial crisis in the eighth regime. The standard devia tion of S&P 500 returns was very high at 4.69% and the average daily return was − 0.65% from September 12, 2008 to December 2, 2008. ^{7} The table also shows that during this time period (regime) the correla tion of VIX with the S&P 500 was substantial, − 87%. This is the highest volatility regime and, interestingly, gold did not have a negative correla tion with the S&P 500 during this important period. In other words, gold was not serving as a hedge when needed most by ﬁnancial market participants. Also note that gold did not have a negative correlation with the S&P 500 in the lowest volatility period (July 25, 2003 to July 9, 2007) as well, but in almost all the other periods its correlation is nega tive. VIX is negatively correlated with the S&P 500 in all ten regimes and the correlation is especially strong during high volatility regimes. This information should be particularly pertinent for investors. Our results are particularly important given that the mainstream news media and literature have paid very little attention to VIX as a candidate for hedging and providing a safe haven. Goetzmann, Li, and Rouwenhorst (2005) ﬁnd that correlations between markets over the past 150 years were strongly inﬂuenced by the globalization of markets and that diversiﬁcation is enhanced by using newer (unexplored) mar kets. Thus, the relatively unexplored market of VIX provides a timely opportunity for investors to use it as a hedge and a safe haven.
^{6} Inclan and Tiao (1994) give a cumulative sum of squares statistic to test the null
hypothesis of a constant unconditional variance against the alternative hypothesis of
a break in the unconditional variance. They further provide an algorithm based on this
statistic to detect multiple breaks in the unconditional variance of a series.
^{7} In order to see if our results will hold if we exclude this unusual time period of very high volatility, the models were reestimated with the sample restricted to the period from November 30, 1995 to September 12, 2008. We found that our overall conclu sions reported in this paper were unchanged. Results are not reported here for the sake of brevity but are available on request.
7. Portfolio analysis
A practical hedge should have a noticeable impact on the risk
(standard deviation) without a noticeable impact on the return (mean) when it is included in a portfolio. Therefore, our ﬁ nal anal ysis is on the descriptive statistics of portfolios consisting of the S&P 500 and either gold or VIX. The market's average daily return is 0.03% with a standard deviation of 1.31% during the 15 years of the sample. Since both gold and VIX are negatively correlated with the mar ket and have higher average returns than the market, it follows that both can provide strong diversiﬁcation beneﬁts. This paper shows that they also provide a strong hedge and a safe haven during market downturns. Fig. 2 shows the risk and return of adding gold or VIX to an invest ment in the S&P 500. The starting point is investing solely in the S&P 500, which yielded an average daily return of 0.03% with a standard deviation of 1.31%, during the 15 years of the sample. However, a combination of 60% gold and 40% S&P 500 has a 37% smaller standard deviation and a higher mean than an investment entirely in the S&P 500. VIX has a much higher standard deviation than the S&P 500 and gold, and is nearly perfectly negatively correlated with the S&P 500, so the scale of a portfolio that includes VIX is much larger and a much lighter weight is required to reduce risk. A portfolio with just 15% in VIX and 85% in the S&P is able to reduce the risk of the market by 42% and still provide a mean return of 0.05%. Fig. 2 clearly shows that from a mean – variance standpoint, gold and VIX are able to dramati cally reduce risk and simultaneously increase returns and that VIX does a better job with a much smaller investment. Investments provide a safe haven by reducing the downside risk of the portfolio. Table 5 shows the ﬁrst ten percentiles of a portfolio that ranges from 100% in the S&P 500 to 85% in the S&P 500 and 15% in gold or VIX. For 1% of all 3777 trading days, the market fell more than 3.46%. The ﬁrst percentile in performance for an investor that had 15% of their portfolio in gold is only down 2.93%, a 16% improvement on the worst outcomes. Across the board, a portfolio with 15% in gold is able to reduce the losses by 13% to 16%. Adding a small amount of VIX to the portfolio instead of gold makes larger improvements. The ﬁrst percentile in performance for a portfolio with 15% in VIX is − 1.83%; this is a 47% improvement in avoiding downside risk. In fact, the sixth percentile for the portfolio that is completely invested in the market has the same − 1.83% return. In other words, a portfolio that is completely invested in the S&P 500 will suffer a loss of 1.83% approximately 1 day in 17, but a portfolio that puts 15% into VIX will suffer such a loss only 1 day in 100. Across the board, a portfolio that puts 15% into VIX can reduce the downside risk approximately in half. This is shown graphically in Fig. 3, which portrays the lowest ten percentiles for a portfolio that is completely invested in the S&P 500 with X's. The dashed line shows the improvement from a 5% stake in VIX, the circles shows the improvement from a 10% stake, and ﬁnally the solid line shows the improvement with a 15% stake in VIX. The portfolio analysis clearly shows that including gold in a stock portfolio will provide a suitable hedge and a safe haven, but our analysis suggests that VIX provides a superior hedge and a better safe haven.
8. Conclusions
In this paper, we evaluate the role of precious metals and volatility
(VIX) as potential tools for hedging (negative correlation with stocks) or providing a safe haven (negative correlation with stocks during ex treme stock market declines) in the US stock market. Using daily data from November 1995 to November 2010, we ﬁnd that gold, unlike other precious metals, serves as a hedge and a weak safe haven for the US stock market. We also ﬁnd that VIX serves as a very strong hedge and very strong safe haven during our sample period. In periods of low volatility and high volatility, gold does not have a negative correlation with the US stock market. On the other hand, the correlation of VIX with the overall stock market remains negative at all times and is even
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M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47 –52
stronger in times of market turmoil (high volatility period). Our overall results suggest that VIX is a superior hedging tool and serves as a better safe haven than gold during our sample period.
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