2012-10: A Comment on “The Cross-Section of Volatility and Expected Returns”: The Statistical Significance of FVIX is Driven by a Single Outlier

Ang, Hodrick, Xing, and Zhang (2006) examine the pricing of aggregate volatility risk and idiosyncratic risk in the US equity market. As part of that study, they propose an ex post factor, F V IX, which is intended as a proxy for aggregate volatility risk at a monthly horizon. Their test validating F V IX as a proxy regresses portfolio excess returns on F V IX and other independent variables over the data period 1986-2000. October 1987 is an outlier, in which the independent variable F V IX exhibits a 26σ deviation from its mean over the data period. The inclusion of a large outlier value of an independent variable results in a spurious reduction of the standard error in a regression, in this case by more than a factor of 2. We find that the statistical significance of their tests of F V IX as a proxy disappears when October 1987 is removed from the data set.