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Is Gold the Best Hedge and a Safe Haven Under

Changing Stock Market Volatility

Article in Review of Financial Economics · April 2013

DOI: 10.1016/j.rfe.2013.03.001

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Review of Financial Economics 22 (2013) 47–52

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Is gold the best hedge and a safe haven under changing stock market volatility?
Matthew Hood a, 1, Farooq Malik b,⁎
a
McCoy College of Business Administration, Texas State University, San Marcos, TX 78666, USA
b
College of Business, Zayed University, P. O. Box 19282, Dubai, United Arab Emirates

a r t i c l e i n f o a b s t r a c t

Article history: We evaluate the role of gold and other precious metals relative to volatility (Volatility Index (VIX)) as a hedge
Received 16 December 2011 (negatively correlated with stocks) and safe haven (negatively correlated with stocks in extreme stock market
Accepted 26 February 2013 declines) using data from the US stock market. Using daily data from November 1995 to November 2010, we
Available online 14 March 2013
find that gold, unlike other precious metals, serves as a hedge and a weak safe haven for US stock market. However,
we find that VIX serves as a very strong hedge and a strong safe haven during our sample period. We also find that
JEL classification:
G1
in periods of extremely low or high volatility, gold does not have a negative correlation with the US stock market.
Our results show that VIX is a superior hedging tool and serves as a better safe haven than gold during our sample
Keywords: period. We highlight the practical significance of our results for financial market participants by conducting a port-
Hedging folio analysis.
GARCH © 2013 Elsevier Inc. All rights reserved.
Volatility
Gold
Safe haven
Volatility shifts

1. Introduction There is widespread evidence suggesting that volatility in stock

In recent years stock markets around the globe have experienced
high volatility and unexpected declining returns. A key question is
which investment vehicles serve as a hedge (negatively correlated with
stocks) or safe haven (negatively correlated with stocks in extreme
stock market declines) in different periods of stock market volatility.
Our paper attempts to answer this important question. We start with
gold as a leading candidate since it receives widespread attention in
the financial news. Jaffe (1989) shows that the addition of gold to various
hypothetical portfolios increases the average return while reducing the
standard deviation. Hillier, Draper, and Faff (2006) note that the major
benefit of precious metals is shown to be their ability to hedge adverse
market conditions because precious metals perform best during periods
of high market volatility. However, the first study which formally tests if
gold is a hedge or safe heaven was done by Baur and Lucey (2010). They
find that gold is a hedge against stocks on average and a safe haven in
extreme stock market conditions using daily data from 1995 to 2005.
Another study on this specific topic was by Baur and McDermott
(2010), who examine the role of gold in the global financial system by
testing the hypothesis that gold represents a safe haven against stocks
of major emerging and developed countries. Using data from 1979 to
2009, they show that gold is both a hedge and a safe haven for the US
and major European stock markets but not for emerging stock markets.
⁎ Corresponding author. Tel.: +971 4 4021545; fax: +971 4 4021010.
E-mail addresses: mh91@txstate.edu (M. Hood), farooq.malik@zu.ac.ae (F. Malik).
1
Tel.: +1 512 2453195.
markets is asymmetric implying that returns and conditional volatility
are negatively correlated. Seminal paper by Christie (1982) documents
and explains this asymmetry based on the leverage hypothesis. He
argues that a drop in the value of the stock (negative return) increases
the financial leverage making the stock riskier thus increasing the under-
lying volatility. These “leverage effects” have become synonymous with
asymmetric volatility although this asymmetric response could be gener-
ated by the volatility feedback effect driven by time varying risk premium
as documented by Campbell and Hentschel (1992). They contend that
news brings higher current volatility and thus increases future volatility
since volatility is highly persistent. This higher volatility raises the re-
quired return resulting in a stock price decline. It is now widely believed
that none of these effects by itself explain the total asymmetry in equity
markets and in reality both effects are in play simultaneously as shown
by Bekaert and Wu (2000). Malik (2011) shows that the negative rela-
tionship is even stronger than previously reported. The remarkably strong
negative correlation between volatility and equity prices during market
downturns offers a timely protection against the risk of a potential capital
loss.2 Based on the reported empirical evidence, we incorporate volatility
into our analysis to see if it serves as a hedge and/or safe haven. A study by
Briere, Burgues, and Signori (2010) shows that a long exposure to volatil-
ity is very valuable for diversifying an equity portfolio, especially during
equity market downturns. However, to the best of our knowledge, this
is the first paper to make a direct comparison between gold and volatility
2
Whaley, the creator of VIX, even suggests that part of the purpose of VIX is to serve
as a hedge to stock investing (Whaley, 2009)

1058-3300/$ – see front matter © 2013 Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.rfe.2013.03.001
 Author's personal copy

48 M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47–52

Table 1
Descriptive statistics.

S&P 500 Gold Silver Platinum VIX

Arithmetic mean 0.03% 0.04% 0.06% 0.05% 0.20%

Geometric mean 0.02% 0.03% 0.04% 0.04% 0.02%
Annualized geometric mean 4.53% 8.84% 11.90% 9.68% 4.80%
Standard deviation 1.31% 1.09% 1.84% 1.48% 6.16%
Skewness 0.00 0.32 −0.77 −0.19 1.02
Kurtosis 10.59 11.13 12.44 8.28 8.79
Minimum −9.03% −6.98% −18.44% −9.22% −29.57%
Median 0.06% 0.02% 0.10% 0.04% −0.33%
Maximum 11.58% 10.79% 14.07% 10.56% 64.22%
Correlation 100.00% −1.83% 9.99% 11.61% −74.08%

Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30, 2010. The correlation for each asset is its correlation with the S&P 500. The annual geometric mean for
each asset is its effective annual rate of return over the entire sample period.

as a potential hedge or safe haven. This information will be particularly
useful to financial market participants since volatility is readily tradable,
with Volatility Index (VIX) on the Chicago Board Options Exchange
(CBOE) being the most prominent derivative.3
Conover et al. (2009) suggest that investors could considerably
improve portfolio performance by adding a significant exposure to the
equities of precious metals firms. Riley (2010) shows that precious metals
have advantages like good expected returns and strong negative correla-
tions with other asset classes. Additionally, studies like Hammoudeh,
Malik, and McAleer (2011) have highlighted the importance of other
precious metals besides gold in risk management. Given the growing
relevance of other precious metals, we also include silver and platinum
in our analysis to see how they compare with gold as a potential hedge
or safe haven.
The econometric approach in this paper is based on a regression
model in which asset returns (gold, silver, platinum, or volatility) are
regressed on stock returns and interaction terms that test whether the
particular asset indeed serves as a hedge or safe haven if the stock market
declines. We use daily data from November 1995 to November 2010. Our
sample period is particularly pertinent as it includes the recent financial
crises. A key feature of equity returns is that volatility is time varying
and undergoes shifts in variance [See Starica and Granger (2005)]. Conse-
quently, we also extend the literature by studying how these different
assets correlate with the stock market within the endogenously deter-
mined volatility regimes.
Our results show that platinum and silver do not serve as a hedge or
safe haven for the US stock market but gold serves both of these func-
tions. Interestingly, VIX serves as a stronger hedge and a better safe
haven than gold during our sample period. We also find that gold does
not have a negative correlation with the US stock market in extremely
low volatility periods or in extremely high volatility periods, but VIX
maintains a negative correlation at all times. Our results suggest that
VIX is a superior hedging tool and serves as a better safe haven than
gold during our sample period. 4
2.1. Hedge
A strong (weak) hedge is defined as an asset that is negatively corre-
lated (uncorrelated) with another asset on average.
However, it has to be noted that a hedge does not necessarily have
the property of reducing losses in periods of extremely declining markets
as the asset could exhibit a positive correlation in such periods and a
negative correlation in normal times which could result in a negative
correlation on average.
2.2. Safe haven
A strong (weak) safe haven is defined as an asset that is negatively
correlated (uncorrelated) with the stock market in periods of extreme
stock market declines.
The specific property of a safe haven asset is the non-positive correla-
tion with the stock market in extreme market conditions. However, note
that this property does not force the correlation to be positive or negative
on average but only to be zero or negative in specific periods of stock
market declines.
3. Data analysis
The data consist of daily closing spot prices for gold, silver, platinum,
the S&P 500 Index, and VIX. All the data used in the paper was obtained
from Bloomberg. The data covers from November 30, 1995 to November
30, 2010. Our sample period is particularly interesting since it includes
the financial crisis of 2008–09. All precious metals are traded at

2. Definitions

Following Baur and McDermott (2010), we define a hedge and a safe

haven as follows:

3
Exposures to volatility can be made by investing in VIX futures contract or an Ex-
change Traded Fund (ETF) on VIX. On the other hand, investment in gold can be made
through a variety of investments. An investor can buy gold coins, gold jewelry, gold
bullion, gold ETF or gold futures. There are more alternatives to invest in gold and some
of them offer investments without a counterparty (futures exchange or ETF provider)
involved with potentially strong implications for a safe haven asset. Fig. 1. Movement in levels of the S&P 500, gold and VIX. Notes: The figure shows the
4
Our results make a timely contribution as during the writing of this manuscript fi- level of the S&P 500 index, VIX and the price of gold for the 15 year sample period
nancial markets across the globe are experiencing unprecedented volatility and declin- from November 1995 to November 2010 (daily data). The S&P 500 index and price
ing returns mainly due to economic problems emanating from Europe. of gold are measured on left vertical axis while VIX is measured on right vertical axis.
 Author's personal copy
M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47–52
Table 2
Asset behavior in declining stock markets.
Quantiles
0.10 0.05 0.01
S&P 500 −2.36% −3.06% −5.10%
Gold 0.11% 0.12% 0.56%
Silver −0.28% −0.53% −0.45%
Platinum −0.23% −0.44% −0.60%
VIX 9.95% 11.68% 17.54%
Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30,
2010. The table shows the average returns of each asset only for the worst 10%, 5%, and
1% days for the S&P 500.
COMEX in New York and their prices are measured in US dollars per troy
ounce. Within the family of volatility indices, the CBOE VIX is widely used
as a benchmark by investors. VIX expresses the 30-day implied volatility
generated from S&P 500 traded options and thus VIX represents a con-
sensus view of short-term volatility in the equity market. The exact
time (Eastern Time) of closing price for gold, silver and platinum is
1:30 pm, 1:25 pm and 1:05 pm, respectively, while S&P 500 Index and
the VIX closing value occurs at 4 pm. Although our use of the
non-synchronous metal return daily data with the S&P 500 is consistent
with the literature but we should point out that it biases against the
hedging potential of the metal indices versus the VIX.
Table 1 provides descriptive statistics for all five series under study.
Among the precious metals and VIX, VIX has the highest arithmetic
mean on a daily basis but its annual geometric mean, which shows the
annual rate of return for the whole sample period, is the lowest. This
low return is not surprising as volatility (VIX) has a mean reverting
behavior. Among the precious metals, we see that silver has the highest
standard deviation while gold has the lowest. The standard deviation for
VIX is more than three times greater than any of the precious metals.
Gold exhibits positive skewness while silver and platinum exhibit nega-
tive skewness. All five series show high values of kurtosis, implying that a
GARCH-type model is appropriate. The last row of Table 1 documents the
correlation of each series with the S&P 500. Gold is the only precious
metal which is negatively correlated with the S&P 500. However, the
negative correlation of gold is trivial relative to VIX, which is strongly
negatively correlated with the S&P 500. Fig. 1 plots the levels of the
S&P 500, VIX, and gold over the whole sample period. A careful review
of the plot reveals the negative relationship between VIX and the S&P
500 especially during 2008.
Another key question in this study is how the precious metals and
VIX behave in conjunction with the S&P 500 on its worst performing
days. Panel A of Table 2 shows the average daily returns on the worst
1%, 5%, and 10% days for the S&P 500. We see that on the worst 1%
days of the S&P 500 it yields an average daily return of −5.10%.5 On
these days, gold and VIX yield a positive return of 0.56% and 17.54%,
respectively – both are positive but the return for VIX is substantially
greater than for gold. On the worst days of the S&P 500, platinum and
silver tend to move in the same direction, which mitigates their effec-
tiveness as a hedge. Overall, we find that gold and VIX have negative re-
lationship with the stock market when the stock market is declining,
but in order to find if that relationship is statistically significant, we pro-
ceed to our econometric model.
4. Econometric model
In this section, we present the econometric model which we use to
analyze the safe haven and hedge property of different assets relative
to the overall stock market. We assume that the price of the asset in
each case is dependent on changes in the stock market and further
assume that the relationship is not constant but is influenced by
5
This is the average of the days’ returns that are in the first percentile, it is not the
first percentile – which will be shown in Table 5.
49
Table 3
Hedge and safe haven assessment.
Hedge Safe haven quantiles
0.10 0.05 0.01
Gold −0.032** −0.070* −0.029 −0.202
Silver 0.000 0.011 0.084 0.027
Platinum 0.099*** 0.024 0.105** 0.217**
VIX −3.303*** −4.534*** −4.015*** −3.595***
Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30,
2010. The estimation results for the role of gold, silver, platinum, and VIX as a hedge
and safe haven asset for daily stock market returns. Negative coefficients in the
Hedge column indicate that the asset is a hedge against stocks. Zero (negative) coeffi-
cients in extreme market conditions [quantile columns (0.10, 0.05, and 0.01)] indicate
that the asset is a weak (strong) safe haven. *, **, and *** represents statistical signifi-
cance at the 10% level, 5% level, and 1% level, respectively.
extreme market conditions. We use the regression model proposed
by Baur and McDermott (2010) which is given as:
Rasset;t ¼ a þ bt Rstock;t þ εt ð1Þ
bt ¼ c0 þ c1 DðRstock q10 Þ þ c2 DðRstock q5 Þ þ c3 DðRstock q1 Þ ð2Þ
2
ht ¼ ω þ αεt−1 þ βht−1 ð3Þ
Eq. (1) models the relationship between each asset (gold, silver, plat-
inum, or VIX) and the stock returns. The parameters to estimate are a and
bt. The error term is given by εt. The parameter bt is modeled as given by
Eq. (2) and the parameters to estimate are c0, c1, c2, and c3. The dummy
variables denoted as D(…) capture extreme stock market declines and
are equal to one if the stock market crosses a certain threshold given
by the tenth, fifth, and first percentiles of the return distribution of the
stock market. If one of the parameters c1, c2, or c3 is significantly different
from zero, then there is evidence of a relationship between the particular
asset and the stock market. If the parameters in Eq. (2) are negative and
statistically different from zero, the asset serves as a strong safe haven.
However, if the parameters are non-positive, then the asset would be a
weak safe haven. The asset would serve as a hedge if the parameter c0
is zero (weak hedge) or negative (strong hedge) and the sum of the
parameters c1 to c3 are not jointly positive exceeding the value of c0.
Finally, Eq. (3) presents a GARCH(1,1) model which is used to account
for heteroscedasticity in the time series data. All equations are simulta-
neously estimated using Maximum Likelihood methods.
5. Empirical results
In this section, we present the results from the model estimated
above. Table 3 shows the estimates of a regression model given by
Eqs. (1), (2), and (3). The table contains the estimates of c0 and the
total effects for extreme market conditions, which is the sum of c0
and c1 for the tenth percentile; the sum of c0, c1, and c2 for the fifth
percentile; and the sum of all four coefficient estimates (c0, c1, c2,
and c3) for the first percentile.
Looking at the hedge column, we find that both gold and VIX serve as
a strong hedge because they have a statistically significant negative
correlation with the S&P 500. However, looking at the corresponding
coefficients, we find that VIX has a far bigger coefficient (in absolute
value) than gold which implies that it is a far more effective hedge
than gold. Silver on the other hand is not correlated with the S&P 500
while platinum has a significant positive correlation which implies that
it not a hedge but co-moves with the overall stock market.
Table 3 also shows which assets are weak or strong safe havens
and which provide no safe haven at all. We find that gold is a strong
safe haven at the 10% significance level. Specifically, we find that on
the worst days of the US stock market, gold correlates negatively
with the S&P 500. Neither silver nor platinum are safe havens.
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50 M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47–52

Table 4
Relationship between VIX and precious metals with the S&P 500 in different volatility regimes.

Starting date 11/30/95 11/30/95 07/29/98 06/14/02 10/17/02 04/02/03 07/25/03 07/09/07 09/12/08 12/02/08 06/01/09

Ending date 11/30/10 07/29/98 06/14/02 10/17/02 04/02/03 07/25/03 07/09/07 09/12/08 12/02/08 06/01/09 11/30/10
All 1 2 3 4 5 6 7 8 9 10

Means
S&P 500 0.03% 0.10% 0.00% −0.16% 0.01% 0.18% 0.05% −0.06% −0.65% 0.12% 0.07%
Gold 0.04% −0.04% 0.01% −0.01% 0.06% 0.10% 0.07% 0.05% 0.10% 0.21% 0.10%
Silver 0.06% 0.03% −0.01% −0.11% 0.02% 0.18% 0.11% −0.04% −0.09% 0.46% 0.17%
Platinum 0.05% 0.00% 0.05% 0.09% 0.06% 0.12% 0.07% −0.02% −0.55% 0.34% 0.10%
VIX 0.20% 0.27% 0.17% 0.64% −0.10% −0.47% 0.14% 0.43% 2.61% −0.52% 0.17%

Standard deviations
S&P 500 1.31% 0.93% 1.33% 2.26% 1.42% 1.05% 0.68% 1.32% 4.69% 2.36% 1.14%
Gold 1.09% 0.66% 0.94% 0.89% 1.10% 1.04% 1.11% 1.39% 3.11% 1.55% 1.05%
Silver 1.84% 1.57% 1.18% 1.02% 1.08% 1.08% 2.07% 2.20% 5.32% 2.36% 1.94%
Platinum 1.48% 1.18% 1.58% 1.13% 1.14% 1.31% 1.19% 1.84% 4.13% 1.83% 1.36%
VIX 6.16% 5.67% 5.83% 6.71% 4.62% 3.50% 5.84% 7.37% 12.57% 5.98% 6.87%

Correlations with the S&P 500

Gold −1.83% −7.93% −9.37% −38.90% −44.76% −33.14% 10.97% −4.04% 7.78% −7.70% 29.84%
Silver 9.99% −3.94% −4.35% −28.72% −30.62% −8.44% 11.59% 5.27% 28.06% 14.81% 49.51%
Platinum 11.61% 3.19% −0.51% 7.80% −1.36% 4.46% 7.10% 5.88% 25.93% 16.73% 55.04%
VIX −74.08% −67.82% −80.72% −85.80% −71.52% −49.53% −77.98% −85.67% −87.46% −78.52% −80.66%

Notes: The sample period is from November 1995 to November 2010. The time periods of volatility regimes were estimated using ICSS algorithm.

However, we see that VIX is a strong safe haven in the case of extreme
negative market shocks at all levels and the correlations are highly
significant. Thus the relationship of VIX to the stock market is much
stronger than it is for gold. In the next section, we explore the rela-
tionship of different assets with the overall stock market under differ-
ent stock market volatility regimes.
6. Evaluating correlations under changing stock market volatility
Several studies have documented a change in correlations between
markets over time. Solnik, Boucrelle and Fur (1996) document the in-
crease in correlations over time (1982 to 1995) and especially during
more volatile periods. Several other studies have examined the asym-
metric increase in correlations during declining markets. For example,
Erb, Harvey, and Viskanta (1994) show that the correlations among the
Group 7 countries are higher during recessions than during economic
growth periods and Longin and Solnik (2001) show that the correlation
between markets increases during bear markets and this correlation is
related to the market trend.
It is also widely documented that markets experience periods where
volatility suddenly increases or decreases [See Starica and Granger
(2005)]. Consequently, in this section we explore the correlations
between different assets with the overall stock market in different
volatility periods. In order to detect the relevant volatility periods or
Table 5
Portfolio behavior in declining stock markets.

0% 5% 10% 15%

Portfolio weight in gold

First percentile −3.46% −3.29% −3.14% −2.93%
Second percentile −2.86% −2.70% −2.57% −2.41%
Third percentile −2.44% −2.33% −2.20% −2.06%
Fourth percentile −2.21% −2.11% −1.98% −1.87%
Fifth percentile −1.98% −1.90% −1.82% −1.74%
Sixth percentile −1.83% −1.73% −1.64% −1.57%
Seventh percentile −1.71% −1.62% −1.53% −1.47%
Eighth percentile −1.59% −1.52% −1.45% −1.38%
Ninth percentile −1.50% −1.43% −1.37% −1.29%
Tenth percentile −1.41% −1.35% −1.29% −1.22%

Portfolio weight in VIX

First percentile −3.46% −2.73% −2.17% −1.83%
Second percentile −2.86% −2.16% −1.67% −1.45%
Third percentile −2.44% −1.88% −1.39% −1.18%
Fourth percentile −2.21% −1.65% −1.24% −1.04%
Fifth percentile −1.98% −1.50% −1.12% −0.96%
Sixth percentile −1.83% −1.36% −1.04% −0.90%
Seventh percentile −1.71% −1.27% −0.96% −0.83%
Eighth percentile −1.59% −1.19% −0.89% −0.78%
Fig. 2. Performance for portfolios of gold and VIX with the S&P 500 from November
Ninth percentile −1.50% −1.10% −0.81% −0.74%
1995 to November 2010. Notes: The red line shows a portfolio comprising of different
Tenth percentile −1.41% −1.03% −0.77% −0.71%
combinations of gold and S&P 500 while the blue line shows a portfolio comprising of
different combinations of VIX and S&P 500. The starting point of both lines shows a Notes: The sample is the 3777 daily returns from November 30, 1995 to November 30,
portfolio with 100% S&P 500. The figure shows that adding gold or VIX to S&P 500 in- 2010. Portfolios are created with an allocation into gold or VIX with the remainder in
creases mean (return) while decreasing standard deviation (risk), and the benefit of the S&P 500. The table illustrates the worst performances over the 15 year period for
adding VIX is more substantial than adding gold. the portfolios.
 Author's personal copy
M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47–52
Fig. 3. Portfolio performance with 0%, 5%, 10%, and 15% invested in VIX (with the rest in the
S&P 500) on the worst 10% of days from November 1995 to November 2010. Notes: The
lowest ten percentiles for a portfolio that is completely invested in the S&P 500 are shown
with X’s. The dashed line shows the improvement from a 5% stake in VIX, the circles shows
the improvement from a 10% stake, and finally the solid line shows the improvement with
a 15% stake in VIX.
regimes, we use the Iterative Cumulative Sums of Squares (ICSS) algo-
rithm given by Inclan and Tiao (1994). This is an endogenous method
to detect structural breaks or shifts in variance (volatility) and this
method has been widely used in the literature. Details of the ICSS
methodology can be found in application papers like Aggarwal,
Inclan, and Leal (1999) and Ewing and Malik (2005) among others. 6
The ICSS algorithm detects 10 volatility regimes in the volatility of
S&P 500 returns during our sample period. The results are documented
in Table 4. One can clearly see the highest volatility regime corresponds
with the recent financial crisis in the eighth regime. The standard devia-
tion of S&P 500 returns was very high at 4.69% and the average daily
return was −0.65% from September 12, 2008 to December 2, 2008.7
The table also shows that during this time period (regime) the correla-
tion of VIX with the S&P 500 was substantial, −87%. This is the highest
volatility regime and, interestingly, gold did not have a negative correla-
tion with the S&P 500 during this important period. In other words, gold
was not serving as a hedge when needed most by financial market
participants. Also note that gold did not have a negative correlation
with the S&P 500 in the lowest volatility period (July 25, 2003 to July 9,
2007) as well, but in almost all the other periods its correlation is nega-
tive. VIX is negatively correlated with the S&P 500 in all ten regimes and
the correlation is especially strong during high volatility regimes. This
information should be particularly pertinent for investors.
Our results are particularly important given that the mainstream
news media and literature have paid very little attention to VIX as a
candidate for hedging and providing a safe haven. Goetzmann, Li, and
Rouwenhorst (2005) find that correlations between markets over the
past 150 years were strongly influenced by the globalization of markets
and that diversification is enhanced by using newer (unexplored) mar-
kets. Thus, the relatively unexplored market of VIX provides a timely
opportunity for investors to use it as a hedge and a safe haven.
6 treme stock market declines) in the US stock market. Using daily data
Inclan and Tiao (1994) give a cumulative sum of squares statistic to test the null
hypothesis of a constant unconditional variance against the alternative hypothesis of
a break in the unconditional variance. They further provide an algorithm based on this
statistic to detect multiple breaks in the unconditional variance of a series.
7
In order to see if our results will hold if we exclude this unusual time period of very
high volatility, the models were re-estimated with the sample restricted to the period
from November 30, 1995 to September 12, 2008. We found that our overall conclu-
sions reported in this paper were unchanged. Results are not reported here for the sake
of brevity but are available on request.
51
7. Portfolio analysis
A practical hedge should have a noticeable impact on the risk
(standard deviation) without a noticeable impact on the return
(mean) when it is included in a portfolio. Therefore, our final anal-
ysis is on the descriptive statistics of portfolios consisting of the
S&P 500 and either gold or VIX. The market's average daily return
is 0.03% with a standard deviation of 1.31% during the 15 years of the
sample. Since both gold and VIX are negatively correlated with the mar-
ket and have higher average returns than the market, it follows that both
can provide strong diversification benefits. This paper shows that they
also provide a strong hedge and a safe haven during market downturns.
Fig. 2 shows the risk and return of adding gold or VIX to an invest-
ment in the S&P 500. The starting point is investing solely in the S&P
500, which yielded an average daily return of 0.03% with a standard
deviation of 1.31%, during the 15 years of the sample. However, a
combination of 60% gold and 40% S&P 500 has a 37% smaller standard
deviation and a higher mean than an investment entirely in the S&P
500. VIX has a much higher standard deviation than the S&P 500 and
gold, and is nearly perfectly negatively correlated with the S&P 500,
so the scale of a portfolio that includes VIX is much larger and a much
lighter weight is required to reduce risk. A portfolio with just 15% in
VIX and 85% in the S&P is able to reduce the risk of the market by 42%
and still provide a mean return of 0.05%. Fig. 2 clearly shows that
from a mean–variance standpoint, gold and VIX are able to dramati-
cally reduce risk and simultaneously increase returns and that VIX
does a better job with a much smaller investment.
Investments provide a safe haven by reducing the down-side risk of
the portfolio. Table 5 shows the first ten percentiles of a portfolio that
ranges from 100% in the S&P 500 to 85% in the S&P 500 and 15% in
gold or VIX. For 1% of all 3777 trading days, the market fell more than
3.46%. The first percentile in performance for an investor that had 15%
of their portfolio in gold is only down 2.93%, a 16% improvement on
the worst outcomes. Across the board, a portfolio with 15% in gold is
able to reduce the losses by 13% to 16%.
Adding a small amount of VIX to the portfolio instead of gold makes
larger improvements. The first percentile in performance for a portfolio
with 15% in VIX is −1.83%; this is a 47% improvement in avoiding
down-side risk. In fact, the sixth percentile for the portfolio that is
completely invested in the market has the same −1.83% return. In
other words, a portfolio that is completely invested in the S&P 500 will
suffer a loss of 1.83% approximately 1 day in 17, but a portfolio that
puts 15% into VIX will suffer such a loss only 1 day in 100. Across the
board, a portfolio that puts 15% into VIX can reduce the down-side risk
approximately in half. This is shown graphically in Fig. 3, which portrays
the lowest ten percentiles for a portfolio that is completely invested in
the S&P 500 with X's. The dashed line shows the improvement from a
5% stake in VIX, the circles shows the improvement from a 10% stake,
and finally the solid line shows the improvement with a 15% stake in VIX.
The portfolio analysis clearly shows that including gold in a stock
portfolio will provide a suitable hedge and a safe haven, but our analysis
suggests that VIX provides a superior hedge and a better safe haven.
8. Conclusions
In this paper, we evaluate the role of precious metals and volatility
(VIX) as potential tools for hedging (negative correlation with stocks)
or providing a safe haven (negative correlation with stocks during ex-
from November 1995 to November 2010, we find that gold, unlike
other precious metals, serves as a hedge and a weak safe haven for the
US stock market. We also find that VIX serves as a very strong hedge
and very strong safe haven during our sample period. In periods of low
volatility and high volatility, gold does not have a negative correlation
with the US stock market. On the other hand, the correlation of VIX
with the overall stock market remains negative at all times and is even
 Author's personal copy
52 M. Hood, F. Malik / Review of Financial Economics 22 (2013) 47–52
stronger in times of market turmoil (high volatility period). Our overall
results suggest that VIX is a superior hedging tool and serves as a better
safe haven than gold during our sample period.
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