A Continuous-Time, Forward-Looking Ambiguity Index

Yehuda Izhakian and Zur Izhakian

Abstract

This paper introduces a realtime, instantaneous, forward-looking measure of ambiguity---the uncertainty of probabilities. Using option price series, it extracts the dynamic continuous snapshot of the expected (implied) ambiguity in the financial markets. Similarly to the VIX, the proposed ambiguity index can be traded. The well-documented negative relation between ambiguity and stock returns suggests a diversification benefit from including an ambiguity instrument in an investment portfolio. Based on the proposed index, ambiguity futures and options can be designed to deliver and trade pure ambiguity exposure in a single efficient package.