I've uploaded the PowerPoint I just made for my presentation tomorrow for the Claremont McKenna College Student Investment Fund.
I was looking at the VIX, and whether or not having exposure to it might serve as a better-than-normal hedge for S&P 500 returns. My thought process was built on the assumptions that:
(1) Assets can be conditionally correlated (i.e. different events can result in different correlations between assets)
(2) In hedging against black swan events (statistically insignificant and unpredictable events that can cause financial ruin), the goal would be to ideally find assets that were uncorrelated to the market during sideways or bullish markets but highly-negatively correlated to market returns during market panics and sell offs.
You should read the presentation for my findings (note: the graphs used are from the Barclays prospectus for their VXX and VXZ ETNs and from Standard & Poor's website. I want to make sure I give credit where credit is due). In terms of my looking at the VIX, I tried to break up my time periods either based on significant market events (for example, the Bear Stearns bailout of their Sub Prime funds) or based on market bottoms or tops. It's somewhat of a mixed bag, but I feel like there's evidence, at least based on recent market history, to suggest that this conditional correlation is partially correct.
In terms of looking at what products to gain exposure to the VIX, I looked at Barclays' iPath S&P 500 VIX Short-Term Futures ETN (VXX) and the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ). While the Short-Term VXX has more liquidity and is more highly correlated to the VIX (and this correlation is more statistically significant), based on the way the indices that both funds are based on move (as seen in the graphs from the Barclays' prospectus I mentioned earlier), I feel that mid-term index has offered a better risk-reward payoff since 2005.
I justify this largely by the fact that humans seem to extrapolate market panic in to the future and to be skeptical during the boom times of future performance. While this skepticism might not be evident in the asset markets themselves, I do believe you'd see it in the derivative markets to insure against these positions.
The expense ratio of 0.89% for both funds is a level I believe to be reasonable, especially faced with the impossibility of effectively creating a product like VXX or VXZ on the small scale for retail investors.
From the articles I've read on the two products, the major complaint that I've heard is that the ETNs don't accurately capture the daily changes in the VIX. While I'm sympathetic to these concerns, I think it's important to remember that you're invested in futures based on the VIX and not the VIX itself (which isn't actually possible). To me it's plausible that you'd actually have meta-volatility (i.e. the volatility of the VIX) impacting the pricing of the products. Also, because the products are looking at what the VIX is going to be at in the future, the day to day movements are less significant.
My final conclusion with the PowerPoint is that I would go long the VXZ. I was not able to get actual data for the index that it is priced off of however, so my statement is more based on the chart and my behavioral explanation for the reason it has outperformed the VXX in both the upside and downside.