Tail risk aversion and backwardation of index futures

Jufang Liang, Dan Yang and Qian Han

Quantitative Finance, 2024, vol. 24, issue 3-4, 387-407

Abstract: We show that tail risk aversion, proxied by the skewness risk premium implied from the SSE 50 ETF options market, explains a significant proportion of the unusually deep backwardation of index futures during the 2015 Chinese stock market crash, while traditional factors such as non-synchronous trading, spot return, volatility and liquidity, all fail to explain the backwardation. These empirical results imply that investors' concern over the crash risk causes speculators to charge a high ‘insurance premium’ on hedgers. On the other hand, short-sale constraints, namely high security borrowing costs and other barriers, prevent reverse arbitrage such that the deep backwardation of index futures persists.

Date: 2024
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DOI: 10.1080/14697688.2024.2330612

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