State-Dependent Correlation Between the S&P 500 and the VIX

Summary

The episode examines how the correlation between the S&P 500 and the VIX is not static but varies across four distinct market regimes defined by levels of volatility (VOL) and volatility‑of‑volatility (VOV) risk. The authors propose a regime‑switching model that shows the strongest inverse correlation occurs in a high‑VOL, high‑VOV state, while the weakest inverse correlation appears in a high‑VOL, low‑VOV state. Empirical findings confirm that VOL and VOV respond to different shocks, making state‑contingent correlations more effective for portfolio construction and hedging than traditional time‑varying correlations. This nuanced understanding helps practitioners refine arbitrage and hedging strategies that rely on the S&P 500‑VIX relationship.