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An index is a statistical measure which describes the changes in a portfolio
of stocks of a specific sector of market. It is thus a mathematical object used
by investors and financial managers to describe and compare specific features of
a market.

Mr. Charles Dow
created the first index ever in May of 1896 and the most widely known until now.
Nowadays it is known as the Dow Jones Industrial Average1
(ticker symbol “DJIA”). Since 1896 many other indices have been created for
example S&P 100, S&P 500, Nasdaq Composite index etc. Other types of
indices are capitalisation indices2,
fixed income indices3,
residential property indices4,
sector indices5,
strategy indices6
and volatility indices, which are analyzed in detail in the next paragraphs.

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   1.2 Volatility Indices and the VIX index

 

Volatility
indices measure the market’s prospect of volatility based on the prices of options.
The most widely used volatility indices is the VIX index of Chicago Board Option
Exchange (CBOE).

The VIX index
is more or less, like the Nasdaq Composite index. Their major difference is
that the VIX measures volatility, that is the unexpected moves either up or down
of an index, and not price. The VIX index (volatility index) was created in
1993 by the CBOE. The index is an instant measure of implied market volatility.
It is calculated by using the mean of real time S 500 options (SPX).

When Whaley
first introduced the VIX index he had two things in mind (Robert E. Whaley
,2008). The first one was that, the index had to become a benchmark of implied
short-term (30- days) market volatility. He also wanted to make the comparison
between the then- current level of VIX with the historical ones, so the minute
by minute values were computed using index option prices of 1986. The choice of
this specific date was not random. 1987 was the period of the worst stock
market crash since the Great Depression, the worst depression that the world
had ever faced until then. This was particularly important since inventors were
able to document the level of market anxiety during a very difficult period for
the economy. The second reason for the creation of the index was the intention of
providing an index which could be used as an underline asset, for futures and options
contracts on volatility. The importance of such trading assets was recognized soon
after they were first launched (futures May 2004 and options February 2006).

1 ?he Dow Jones Industrial
Average (DJIA) contains 30 of the largest and most influential companies in the
U.S.

2 Capitalisation indices
represent the sum of the market capitalisations of the companies making up the
index (www.asx.com.au)

3 Fixed income indices measure the
performance of the bond market and the short-term money market. (www.asx.com.au)

4 Property indices are similar to other
asset performance indices in that they measure changes in the market value of
the asset class in question, in this case residential property. (www.asx.com.au)

5 Sector indices enable investors to
benchmark the performance of a particular stock market sector or industry.
(www.asx.com.au)

6 Strategy indices track the performance
of a particular investment strategy (www.asx.com.au)

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