Revisiting why realized and expected volatility are so low

by on May 12, 2017 at 11:36 am in Current Affairs, Economics | Permalink

An email from Alebron:

Might it be worth revisiting this, since it’s been 3 years?

Vol is low right now, lots of hand-wringing about it. Some possible factors:

– Shiller used to say the puzzle was that equity vol was so high (at least in the context of plausible DCF models). More money is now in the hands of “smart” market participants (certainly as a fraction of total trading volume this is true), and they overreact less to news.

– Stagnation/complacency. Or alternatively, all the action is in private firms (unicorns and the like). Firms only go/stay public if they are boring/stable.

– Consider a model where an industry has n firms, and some of them are mismanaged but investors don’t know which ones. Then any news about one of them reveals something about which are the good/bad ones. Suppose that the spread of (a) management consulting, (b) corporate regulation, and (c) efficiency due to information technology brings everyone towards the mean. Bad companies aren’t as bad as they used to be (they have access to competitors’ good ideas, Dodd-Frank/SOX/etc prevent egregious mis-management/mis-reporting, etc), and good ones aren’t as good (their good ideas leak out, they get saddled with unavoidable costs due to Dodd-Frank/SOX/etc). Thus, the value of news decreases, vol decreases.

– Trump of course. Pro-business, but more accurately pro-big-business, or pro-rent-seeking? I’m inclined to mostly dismiss this, since it’s not like vol cratered when he got elected. Vol has been pretty low for most of the last 5 years.”

– Does 1990s low-vol Japan have lessons?
Curious if you have other thoughts…

The excellent Samir Varma sends me this new article on VIX and volatility.  We all know there are models where volatility begets further volatility, if only because the initial big price moves make investors more wary, less willing to hold some positions, and more willing to bail out of others.  Perhaps we need a more in-depth study of how non-volatility begets further non-volatility.  When prices just aren’t moving by very much, maybe certain kinds of information get drained away, and it becomes harder to conclude that some position other than your status quo default position makes sense.

1 prior_test2 May 12, 2017 at 4:01 pm

So, it seems as if people get the homeric epithet of ‘excellent,’ while things get the homeric epithet of ‘self-recommending.’ At least that could be one Straussian reading.

Though truly, one wishes for the apotheosis of ‘excellently self-recommending’ or ‘self-recommendingly excellent.’ Along with the hope that one stays true to such verbal tics, instead of actually spending a moment to find a suitable adjective – insightful, intelligent, incisive, imaginative, imposing, intrepid, impartial, incandescent, incredible, indefatigable, inspired, intuitive, impressive, to give a few that start with ‘i’. After all, Homer did not vary his epithets either.

2 msgkings May 12, 2017 at 4:09 pm

It could be as simple as stagnation/slow growth full stop. Everything’s “low”: low growth, low (but positive) returns, low interest rates, low inflation, low population growth, low volatility etc. The Great Stasis.

3 Anooj Pakvasa May 12, 2017 at 4:21 pm

James Joyce (1882–1941) in chapter twelve of his masterpiece, Ulysses, (1922) has “The tribe of Caolte (quilty)” as one of the twelve tribes of Ireland in a biblical parallel to the twelve tribes of Israel.

I wondered idly if some surgeon of genius might not alter his own career, and perhaps the whole destiny of mankind, by reviving quilted, Quilty, Clare Obscure.

-Vladimir Nabokov, surely a prophet ibid 1947, for score and forty seven years ago, the real life of Sebastian knight held score and kept a cookie

4 anonymous May 12, 2017 at 11:03 pm

Nabokov was not sufficiently talented or intelligent to understand Finnegans Wake (his “parody” of it – I read it somewhere, I am not sure where – demonstrates that he had no idea what Joyce was trying to do but still thought himself “bookish” and “funny” enough to joke about it…. sad ! …. so there’s that – as an argument against his accuracy about the world he lived in)……………………….
Joyce’ masterpiece was not Ulysses but Finnegans Wake……………………….
And that was nowhere near as good as Shakespeare…………………………
And Shakespeare, bless his talented little heart, was nowhere near as good as the real prophets………………….
as the rivers of waters in a dry place, as the shadow of a great rock in a weary land.
and it gets better than that.

5 anonymous May 12, 2017 at 11:05 pm

the rivers of waters in a dry place, the shadow of a great rock in a weary land —– that is where you want to start.

6 efim polenov May 12, 2017 at 11:40 pm

to be fair to the pair of st petersburg writers(1799/1899) Nabokov never once so much as hinted he thought he might be as talented as Pushkin and Pushkin in turn wrote poems imagining a better version of himself as a humble poet seeking the same inspiration Isaiah gloried in. Neither one would argue much or at all with the 11:03 pm post.

7 Amigo May 12, 2017 at 5:03 pm

I wonder if this is true for individual securities as well as the broader market volatility that the VIX is designed to measure?

In my portfolio there are stocks that bounce around quite a bit, and I wonder if they all bounce around cancelling each other out on the whole, masking the roiling movements of money bouncing between securities rather than in and out of the market as a whole driving it up and down. I have nothing to base this thought on other than watching my portfolio, but if someone didn’t tell me volatility was low I wouldn’t know it.

8 Brian May 12, 2017 at 5:36 pm

In order for individual stocks to have high volatility and the market to have low volatility correlations would have to below or even negative. I don’t have the trailing 6 months S&P correlation sitting in front of me, but I’m confident that they are not negative, and probably still quite high.

9 Dan Lavatan-Jeltz May 12, 2017 at 6:48 pm

Most of the market is controlled by weighted index funds. If they invest less in one stock, they have to invest an equal amount in another one so they overall market increases by exactly the amount of the money funneled into 401k trusts each month.

10 Cyrus May 12, 2017 at 9:42 pm

Savings glut theorists took a bit haircut in 2008.

11 P May 16, 2017 at 5:25 pm

Correlations have been very low recently.

12 Anonymous May 12, 2017 at 5:09 pm
13 Matthew Young May 12, 2017 at 5:20 pm

We are in permanent wait for the senate to tell us about the exciting anti-gravity machine they invented with the 2,4 trillion Fed loan.

14 rayward May 12, 2017 at 5:46 pm

The run-up in housing prices is only exceeded by the run-up in stock prices. I don’t understand either. People buy houses at these ridiculous prices today because they fear the prices tomorrow will be even higher. People buy stocks at these ridiculous prices today because they expect the prices tomorrow will be even higher. Of course, there’s no rational reason to expect higher prices tomorrow, only the irrational expectations of buyers. In the old days, when stock were valued based on future earnings, there was rationality for buying stocks with high P/E ratios; today, there’s no such rationality. People buy stocks for the same reason they buy houses: the expectation that prices tomorrow will be higher than prices today. Good luck with that. I’m not looking forward to Cowen’s Big Reset, for it may bring rationality back to markets. Lots of pain, for sure, but rationality too.

15 Bill May 12, 2017 at 6:29 pm

Volatility is low because of legalized marijuana.

16 The Other Jim May 12, 2017 at 7:07 pm

>Trump of course. Pro-business, but more accurately pro-big-business

This is the kind of partisan crap that Tyler just effortlessly lets slide by, because it is all he ever hears in his bubble.

Much like claims that Trump is “homophobic,” despite the fact that he supported gay marriage LONG before Obama, or the Dem media, or even one the earliest adopters of the movement – Dick Cheney.

Keep stagnating, Tyler.

17 msgkings May 12, 2017 at 7:35 pm

OJ still fighting the good fight against partisan crap.

18 Anon_senpei May 12, 2017 at 10:04 pm

I agree it’s a claim that requires support, considering that small business owners are overwhelmingly​ Republican and regulations (which Trump had campaigned against and Democrats generally support) favor businesses large enough to deal with the extra overhead.

19 Anonymous May 12, 2017 at 7:24 pm

Tyler would probably like to keep the VIX question somewhat apart from Trump and current affairs.

I can kind of understand that, because if you want to talk Trump elsewhere today, you certainly may:

Rarely is that front page as aligned on one topic.

Still, if Tyler leans towards Fama more than Shiller, this is a conundrum. When the world is seemingly on fire, why would markets be calm? Josh Brown (above) says it’s because markets sussed this long ago.

I am a little more Shiller, and I think markets can be weird, whenever they want. What will happen next, in politics or markets is, as usual up in the air.

20 msgkings May 12, 2017 at 7:37 pm

The world isn’t on fire, that’s your hair.

21 Anonymous May 12, 2017 at 7:42 pm

Tyler, at least, reads widely.

Your particular fantasy is that MR comments are the world.

22 msgkings May 12, 2017 at 8:03 pm

No, yours is that the rest of the world is as deranged as you are.

23 Anonymous May 13, 2017 at 9:36 am

One of us in the position of waving away all news, to maintain an established world view, but it isn’t me.

“CNN panel on Friday debated why President Donald Trump has behaved so impulsively over the past week when it comes to the firing of former FBI Director James Comey. Their conclusion? The president is simply out of control — and there’s no hope of reeling him in.”

24 msgkings May 13, 2017 at 2:47 pm

LOL no

25 Anonymous May 13, 2017 at 3:16 pm

Apparently CNN has it bad:

“President Donald Trump’s firing of FBI Director James Comey has uncoiled a whole administration’s worth of shocks, contradictions and blockbuster moments.

Those shocks will continue to reverberate next week and beyond because the issues involved are fundamental to American democracy, challenging the credibility of the White House and the vital legal institutions that sustain government.”

26 Jack May 12, 2017 at 8:43 pm

interesting point — the greater participation of market professionals. Does the data support that?

27 carlospln May 12, 2017 at 8:57 pm

Alebron’s naivety is touching.

Corporate regulation? Anti-trust regulation has been completely abrogated by successive Repub & Dem administrations over the last thirty years. Ever wonder why there are just three airlines? Or that almost any industry vertical is now an oligopoly? And fraud has been decriminalised, most grotesquely in the banking sector.

“Dodd-Frank/SOX/etc prevent egregious mis-management/mis-reporting, etc)”. [SNIP]

Frank ‘n Dodd was a tedious ‘tick ‘n flick’ exercise written by the lobbyists of the Big Five banks, designed to create a numbing compliance burden on the v smallest, in order for to roll them up.

Sarbannes-Oxley has never been enforced by the SEC, itself a toothless regulator since Arthur Levitt neutered it in the Clinton administration.

And don’t even get me started on corporate tax evasion.

28 Nehru May 12, 2017 at 11:42 pm


T.S Elliot is a great poet, weeping at the water’s of leman (read Babylon).

but if you sing Gandhi’s daily bhajan:
the beauty part at least:
pīḍa parāyī jāṇe re,
para duḥkhe upakāra kare to ye
mana abhimāna na āṇe re

You already know Jesus Christ died on the cross, so we could learn to love one another and learn to live forever.

Banks are undervalued.

29 jon May 13, 2017 at 12:26 am

1) Short-term market outcomes condition long(er) term behavior: short vol/long risk has been profitable, for the most part, for 8 years. Most can’t fight that. No one wants to have to explain why he/she lightened up, bought protection, or (god forbid) got short before a 10/20/30 % ramp – better to suffer together than all alone.

2) Central Banks have learned the lesson: assure that risk assets are the place to be. If you buy a not insignificant chunk of the world’s financial assets, guaranteeing to do more if conditions warrant, you support risk assets(pushing vol down implicitly) and reduce the perceived symmetry in intermediate-term outcomes(pushing vol expectations down explicitly). When the biggest traders in the world ‘sell’ puts it’s bound to push vol, and forward vol, lower. This, along with ‘low’ rates providing few investment alternatives, pushes everyone to one side of the boat while incentivizing them not to rock it.

3) Policy and economic conditions have been conducive to high (seemingly stable) corporate margins, low capex, and financial engineering: cost-cutting, conservative outlooks, and buy-backs tend to dampen perceived earnings vol

30 basquiat May 13, 2017 at 12:34 am

Wealth and alcohol-drugs are of course overvalued.

31 Highgamma May 13, 2017 at 7:00 am

We need to distinguish between diversifiable risk and systematic risk. Systematic risk is very low. Similar to late 1993 when correlations between stocks dropped to zero.

32 Bill May 13, 2017 at 8:35 am

Good point.

Thank you Dodd-Frank.

33 Mike May 13, 2017 at 9:49 am

Four observations:

1. Downside volatility has been much more muted that upside volatility. This is unusual – most of the time downside moves are associated with higher volatility. This suggests perhaps that buyers are waiting to come in on any dips.

2. Recent autocorrelation of volatility has also been much lower than long term history suggests (any vol spikes have been immediately reversed).

3. Although VIX is at historical lows, the premium of implied over realized vol is actually high on a percentage basis… so you can sell vol at ~11 while realized is <7. There is probably a floor on implied vol but not one on realized. So even though VIX is low this can be the best type of environment for systematically selling vol.

4. There have been reports of institutions systematically selling vol. Obviously this has worked out fabulously and probably attracts new investors to the strategy. These guys are probably just selling options and holding until expiry, but the dealers who they are trading with are delta hedging on a daily basis… but if only the long gamma holders are delta hedging, this itself will suppress volatility as they will be buying on every dip and selling every rally.

34 Techreseller May 15, 2017 at 4:20 pm

Or dumb money finally (like me) figured that Index funds give a good enough return and reduce a lot of stress and fees. index fund investing almost by definition reduces volatility because so much money on those funds remains extremely stable.

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