QuoteOriginally posted by: gardener3QuoteOriginally posted by: AlanQuoteOriginally posted by: gardener3QuoteOriginally posted by: AlanGood point, EBal, re Keynes. It raises the question I touched on in this thread. Namely, in very stressed markets (like the Financial Crisis),we have nominal backwardation (the spot VIX is higher than the futures and their term structure is downwardsloping. But, to use your or acastaldo's language, I wonder if we still have Keynesian contango in thosesituations? (so the expected spot VIX at future time T is lower than the current VIX future maturing at T) Certainly with mean-reversion, the spot would be expected to fall. So it's potentially self-consistent.But with very pronounced nominal term structure inversion, it is somewhat counter-intuitive to me that the market expects thespot to fall that much. What is your take on that type of situation?It should be easy to test. If VIX(t) - VIXfuture(t,T) is highly positive then VIX(T) - VIXfuture(t,T) should be positive, if I understood you correctly.Good point re testing. But if EBal's Keynesian natural contango is right (in all VIX markets, stressed or not), then I think the hypothesis here is that the realized value of VIX(T) - VIXfuture(t,T) is, on average, negative, (suggesting VIX futures are always expected to fall), regardless of the sign of VIX(t) - VIXfuture(t,T). At least that is my interpretation of what EBal is saying about (the proper application of) Keynes' theory to VIX. And you're right: that should be easy to test.The average is very negative as ebal mentioned (although if you take the inverse and include the crisis, they are not as good as vxx would suggest). I was referring to the relationship you mentioned earlier that when the curve is inverted, the vix mean reversion would be less than expected by the market. In other words, would VIX(t) - VIXfuture(t,T) help predict VIX(T) - VIXfuture(t,T)I've run quite a few regressions concerning that question now.I find log VIX(t)/VIXfuture(t,T) is a very weak explanatory of the holding period return.Regardless of the holding period, the R^2 are low: (0.01 - 0.04) range. However the sign of its regression contribution is what you would expect, given my earlier table and/or common sense. The only t-stats > 2 I've seen are for the shortest possible holding period: buying the expiring future on the Tues close prior to its Weds am expiration. Even for that one, the R^2 is only 0.045 and the unconditional annualized mean log-return is -58%/yr
Last edited by Alan
on February 11th, 2014, 11:00 pm, edited 1 time in total.