What is the CBOE SKEW INDEX SSKEW and how does it work?
The CBOE SKEW Index itself isn’t a recession predictor in the traditional sense; rather, it provides insight into market participants’ perceptions of tail risk—particularly the likelihood of extreme negative events in the equity markets. However, its behavior can serve as one of several cautionary signals that, in aggregate with other indicators, may hint at economic stress or the potential for economic downturns. Here’s how:
Reflecting Concerns Over Extreme Downside Moves:
A rising SKEW suggests that investors are increasingly pricing in the possibility of severe market declines. Since economic recessions are often accompanied by dramatic drops in asset prices (reflected in equity markets), a higher SKEW may indicate that market participants are anticipating conditions that could lead to or coincide with a recession.
Risk Aversion Among Market Participants:
When the SKEW is elevated, it implies that investors are hedging against tail risks by buying out-of-the-money (OTM) put options—or are otherwise willing to pay a premium for protection against catastrophic market moves. This heightened risk aversion can sometimes come before broader economic uncertainty and downturns.
Historical Correlations and Research Findings:
Some studies and market analyses have found that periods marked by a persistently high SKEW (relative to its long-term average) have sometimes preceded or coincided with economic downturns. That said, the SKEW is not used in isolation to predict recessions; it’s one of many market sentiment indicators that analysts may look at when assessing broader economic risk.
Complement to Other Economic Indicators:
VIX vs. SKEW: While the VIX measures overall expected volatility (including both upside and downside moves), the SKEW focuses more narrowly on the risk of extreme negative moves. In periods leading up to a recession, investors tend to become more concerned about downside risk, which may be more clearly reflected in the SKEW.
Broader Context: Analysts and economists generally combine various signals—such as inverted yield curves, credit spreads, unemployment data, consumer sentiment, and other volatility measures—with the SKEW to form a more comprehensive view of economic vulnerability.
Not a Standalone Forecasting Tool:
It’s important to emphasize that while an increasing SKEW index can indicate elevated fears of significant market downturns (which might accompany or even trigger broader economic recessions), it is not a deterministic predictor of a recession. Instead, it should be viewed as one piece of a larger puzzle. Other macroeconomic indicators and models are always considered to form a balanced view of the economy’s health.
Summary
While the CBOE SKEW Index doesn't directly predict recessions, its ability to capture the market's expectations of "black swan" or tail risk events makes it a valuable barometer of investor sentiment and potential market stress. When the index is high, it signals that investors are wary of large, negative market moves—an environment that can sometimes be associated with or precede broader economic slowdowns. Nonetheless, analysts typically integrate the SKEW with other economic and financial data to assess recession risks more comprehensively.
The CBOE SKEW Index itself isn’t a recession predictor in the traditional sense; rather, it provides insight into market participants’ perceptions of tail risk—particularly the likelihood of extreme negative events in the equity markets. However, its behavior can serve as one of several cautionary signals that, in aggregate with other indicators, may hint at economic stress or the potential for economic downturns. Here’s how:
Reflecting Concerns Over Extreme Downside Moves:
A rising SKEW suggests that investors are increasingly pricing in the possibility of severe market declines. Since economic recessions are often accompanied by dramatic drops in asset prices (reflected in equity markets), a higher SKEW may indicate that market participants are anticipating conditions that could lead to or coincide with a recession.
Risk Aversion Among Market Participants:
When the SKEW is elevated, it implies that investors are hedging against tail risks by buying out-of-the-money (OTM) put options—or are otherwise willing to pay a premium for protection against catastrophic market moves. This heightened risk aversion can sometimes come before broader economic uncertainty and downturns.
Historical Correlations and Research Findings:
Some studies and market analyses have found that periods marked by a persistently high SKEW (relative to its long-term average) have sometimes preceded or coincided with economic downturns. That said, the SKEW is not used in isolation to predict recessions; it’s one of many market sentiment indicators that analysts may look at when assessing broader economic risk.
Complement to Other Economic Indicators:
VIX vs. SKEW: While the VIX measures overall expected volatility (including both upside and downside moves), the SKEW focuses more narrowly on the risk of extreme negative moves. In periods leading up to a recession, investors tend to become more concerned about downside risk, which may be more clearly reflected in the SKEW.
Broader Context: Analysts and economists generally combine various signals—such as inverted yield curves, credit spreads, unemployment data, consumer sentiment, and other volatility measures—with the SKEW to form a more comprehensive view of economic vulnerability.
Not a Standalone Forecasting Tool:
It’s important to emphasize that while an increasing SKEW index can indicate elevated fears of significant market downturns (which might accompany or even trigger broader economic recessions), it is not a deterministic predictor of a recession. Instead, it should be viewed as one piece of a larger puzzle. Other macroeconomic indicators and models are always considered to form a balanced view of the economy’s health.
Summary
While the CBOE SKEW Index doesn't directly predict recessions, its ability to capture the market's expectations of "black swan" or tail risk events makes it a valuable barometer of investor sentiment and potential market stress. When the index is high, it signals that investors are wary of large, negative market moves—an environment that can sometimes be associated with or precede broader economic slowdowns. Nonetheless, analysts typically integrate the SKEW with other economic and financial data to assess recession risks more comprehensively.