Using Hurst Exponent on the Volatility of Volatility Indices

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A market regime refers to a distinct phase or state in financial markets characterized by certain prevailing conditions and dynamics. It describes the overall behavior and patterns observed in asset prices, market volatility, and trading activity. Two common market regimes are mean-reverting and trending regimes. In a mean-reverting regime, prices tend to fluctuate around a long-term average, with deviations from the mean eventually reverting back to the average. This type of regime is often associated with range-bound or sideways markets. On the other hand, in a trending regime, prices exhibit persistent directional movements, either upwards or downwards, indicating a clear trend. Trending markets are characterized by momentum and sustained price movements in one direction, making them attractive for trend-following strategies. Understanding the prevailing market regime is crucial for traders and investors as it helps inform their strategy selection and risk management approaches.

Reference [1] proposed the use of the Hurst exponent on the volatility of volatility indices in order to characterize the market regime. The authors pointed out,

The main contribution of this work is the computation of the Hurst exponent through the volatility measures by using data from five international markets during the period of January 2001 to December 2021. Based on these values of the Hurst exponent, we analyze the trace behavior of three trading strategies, i.e., the momentum-based strategy, the random walk, and the mean-reversion strategy. The values of the Hurst exponent on the volatility of volatility indices better reflects the period’s changes than the values of the Hurst exponent on the volatility indices (hypothesis (H1)). The results are highly recommended for financial analysts dealing with volatility indices as well as for financial researchers.

In short, the article highlights the effectiveness of employing the Hurst exponent on the volatility of volatility indices as a suitable method for characterizing the market regime.

We have employed the Hurst exponent on both stock market data and volatility indices to effectively characterize the market regime. This article serves as another intriguing application of the Hurst exponent, highlighting its versatility and usefulness in analyzing market regimes.

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References

[1] Georgia Zournatzidou and Christos Floros, Hurst Exponent Analysis: Evidence from Volatility Indices and the Volatility of Volatility Indices, J. Risk Financial Manag. 2023, 16(5), 272

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