What does low volatility in asset prices mean?

The excellent Gillian Tett has some interesting (and speculative) thoughts on this question, putting a new twist on Hayek:

But there is a second, less benign possible reason for low volatility: markets have been so distorted by heavy government interference since 2008 that investors are frozen. One issue that may account for the pattern, for example, is that tougher regulations have prompted banks to stop trading some assets. Another is that ultra-low interest rates have made investors reluctant to deploy their cash in public, liquid markets.

And there could be a more subtle issue at work too: investors are so unsure what to make of this level of government interference that they are unwilling to take any big bets. Far from being a sign of sunny confidence in the future, ultra-low volatility may show that investors have lost faith that markets work.

In reality, nobody knows which of these explanations holds true; I suspect that government meddling and low interest rates are the key factors here, but academic research on this issue is thin. However, one thing that is clear is that the longer this pattern remains in place, the more wary investors and policy makers should be.

The rest of the FT article is here.


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