Market Volatility
People have been asking me whether yesterday’s stock market drop indicates a significant incipient increase in volatility. The answer, I’m now quite confident, is maybe.
That’s not such a trivial answer, really. If you have a subjective probability distribution concerning volatility, you should definitely revise upward the mean of that distribution. In most cases, that means acting as if there has been a moderate, but not large, increase in volatility. There is a very good chance that the actual increase in volatility will turn out either to be very small or to be quite large. Given the possibility that it could be quite large, there is reason to change ones behavior, but since that is only a possibility, the change in behavior probably should not be dramatic.
That’s not such a trivial answer, really. If you have a subjective probability distribution concerning volatility, you should definitely revise upward the mean of that distribution. In most cases, that means acting as if there has been a moderate, but not large, increase in volatility. There is a very good chance that the actual increase in volatility will turn out either to be very small or to be quite large. Given the possibility that it could be quite large, there is reason to change ones behavior, but since that is only a possibility, the change in behavior probably should not be dramatic.
Labels: capital, economics, emotions, finance, macroeconomics
posted by knzn at 2/28/2007 10:37:00 AM
7 Comments:
The CBOE volatility index chart is quite interesting.
I guess if you are a directional player then vol has a more significant meaning. What has happened to the true concept of investing though? Perhaps given todays performance this sounds like 20/20 hindsight but were the economic numbers in the US and China's cap gains issue fundamental drivers? With the markets performing as they did today I would argue not. But shame on "investors" for not using their brains. Too much information is dangerous when people only focus on the surface and ignore the need to dig deeper. Risk premiums are way too low, the events of two days ago is definately a crack in the foundation. When you are a true investor, it doesn't matter what the catalyst is for the downturn but rather that you know it is out there. At recent levels, who could argue that vol wouldn't increase in the future? It's a little bit like asking "if you throw a ball into the air, will it come back down?"
I like your commitment there! Serious, I like your blog and the approach you are taking. I discussed the market changes at www.bizplusblog.com as well. Although I remain up beat, there is plenty of room for concern.
By the way: Sebastian Dullien has also brought forward of a NAIRU curve with a horizontal area. See his article: "Rethinking the Role of Monetary Policy and Wage Bargaining in a World Without the Real Balance Effect", in: Intervention. Zeitschrift für Ökonomie, Vol. 3, No. 2, 2006, p. 279-304.
His graph looks pretty much like yours on your earlier post. However, I have never seen the idea in mainstream economics. Do you have other sources?
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