Market Volatility: with thanks to True Economics

True Economics, has very interesting charts of 3-sigma-plus stock market volatility accross the UK, France, Germany, the US and world stock markets.

To argue that the ongoing period of volatility represents a repricing of stock markets, associated with the financial crisis, requires the interpretation that the European sovereign debt crisis is only but another stage of the crisis that began with the subprime crash in the USA, back in 2007.

However, looking at it from the purely mechanical point of view of a spring, I guess the repricing can be understood as the fall in volatility, so that any repricing would follow peaks and troughs. This would of course still imply that markets have imperfect information, but that the shocks and readjustments occur faster than suggested by that post. In this case the sovereign debt crisis would not have been foreseen by stock markets and its impact would have followed rather than accompanied the financial crisis of 2007-2009. The decrease in market volatility after Lehman’s bankrupcy would correspond to a first price adjustment which completely missed the potential for a sovereign debt crisis, only to catch up to it two years later.

Finally, caution should be used in understanding 3-sigma-plus volatility as extraordinary. Although it is potentially a good rule-of-thumb measure of extreme volatility, any such consideration should keep in mind that stock market returns may be better described by specific stable distrbutions than by normal ones, as argued by Mandelbrot, and so are more naturally prone to extreme values. If you are interested in this topic, you can find further information here, here, here and here (R package discussion here).

This is all a bit geeky, but it’s important. If traders and quants had kept this in mind we probably would have avoided the financial crisis, which would not have saved us the trouble of the sovereign debt crisis.

This entry was posted in A € for your Thoughts, Aides Memoire, Economic Concepts, Sovereign debt Crisis and tagged , , , , , , . Bookmark the permalink.

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