Do not Fear the Fear Index: Evidence from US, UK and European Markets

The VIX index is popularly known as “the fear index” both in the business media and in academic literature. Following the popularity of the VIX, similar indices were introduced in the UK and European stock markets as an indication of investor uncertainty. In this article, we investigate this popular idea by examining whether these indices indeed reflect investor fear. The results of long horizon predictive regressions show that these fear indices as well as extreme jumps in them fail to predict statistically significant negative market returns up to next five years. Moreover, response of valuation ratios and leading business cycle indicators to shocks in the fear indices are statistically insignificant. However, monetary policy in US, UK and Europe appear to respond significantly to fear indices. Collectively, the results imply that long-term investors do not need to fear these fear indices.