Minyan Mailbag: Volatility
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
I know that you and Professor Succo have discussed the current low volatility, but my screens are now showing multi year lows. Is there some sea change going on here? Is it the equivalent of the polar ice caps melting? If it is true VIX is directly related to lack of concern for the markets, maybe I am the only one in the world not entirely comfortable today. Is this just all traders overwriting options in an attempt to generate whatever minuscule cash flow is possible?
I am confused.
Markets are all about cycles and volatility is no different.
Right now the markets are starved for returns, whatever form they may take. Liquidity, as defined by the supply of money (fiat money), is at an all-time high. This has caused investors to take extraneous risks in order to obtain those returns. An example is credit. Spreads have narrowed to near historic levels as insurance companies, banks, and bond funds have stretched their risk tolerance to buy corporate bonds in one form or another (mostly through the synthetic markets) to earn "a little extra yield". As everyone stretches a little bit more, the process feeds on itself and volatility comes in even more. That is until it snaps back.
The process will end when the market realizes all at once that it has accepted too much risk, or in other words, the risk premium associated with assets is too low. The by-product of the above process is debt, but no one knows when there is too much debt until it becomes obvious. It is like filling a bag with a little sand at a time or the straw that breaks the camel's back.
So yes, low volatility is in a way complacency. It simply means that risk premiums are going lower. The accumulation of debt is a slow process. The unwind is not.
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