Monday, May 25, 2015

Volatility: The Force Awakens

My best guess is this year will be remembered for the end of the volatility comatose we witnessed ever since the global QEs flushed the financial markets and beat the life out of vol across asset classes.

With this perspective we take a look at long term and more recent history of vols across asset classes. Volatility itself is a bit hard to define. On top given the differences among asset classes it is quite an effort to compare vols across asset classes. Here we take a simple approach to work around. Below figures show the running count (i.e. cumulative count) of number of times an asset class has moved 2.5 times of it's half yearly weekly volatility in a given week. This simple measure standardizes all volatility to a simple number, irrespective of how volatile the asset class is or how you measure the volatility itself.

A long term look at asset classes shows some interesting things - like how oil (on a longer horizon) has been much less volatile than rest of the commodities (which incidentally show most volatility). If you take S&P as the benchmark, only commodities (ex oil) come on top. The second chart shows a closer look, since 2010 (after the initial impact of the financial crisis). We see a long period of subdued volatility. With S&P as the benchmark again, till early last year, only commodities (ex oil) was beating it, as before. Then something happened. Later in 2014, first the dollar picked up in vol, followed closely by Euro, and then oil, and finally Bunds. Only treasury remains below S&P in terms of vol. As of now that is.

This clearly shows the trend, and we will definitely see more uptick in vol for the rest of this year. Perhaps driven by the much anticipated Fed rate hike. But more fundamentally, vol can happen without any reason, because high vol just happens sometimes!

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