Volatility Uncertainty and VIX Futures Contango
46 Pages Posted: 16 Dec 2021
Date Written: September 25, 2021
The VIX futures curve is most often in contango but displays backwardation during unfavorable market conditions. We construct an explanation based on the notion of stochastic orders of volatility uncertainty – meaning that investors view short-dated volatility uncertainty as being less likely to take on larger values than long-dated volatility uncertainty – under all pricing measures. We complement this theory with tractable equity price processes, whose paths consist of continuous shocks interspersed with jump discontinuities, the latter reflecting disaster uncertainty with time-varying disaster probability.
Keywords: VIX futures curve, stochastic orders, hedging instruments, contango
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