VIX Shows Greater Sense of Uncertainty in the Markets

I just did some analysis of VIX (the index of the implied volatilities in S&P 500 options created by the Chicago Board of Options Exchange) data from 2004 to this Tuesday (15 Jan. 2008). The VIX is widely considered to be the one of the best indicators of the market's sentiment on volatility, risk, and uncertainty.

If you look at the chart I created (see below -- click it to see a larger image), you can clearly see that -- from late Summer of 2007 -- the market's consensus on volatilty has been elevated to a substantially higher level. Another thing that is striking from this chart I created is how 'jumpy' risk is. Not only are there sizable spikes but there seems to be some anecdotal evidence of what econometricians call 'regime switching.' In this case, the regime we have switched to is that of higher volatility and uncertainty in the marketplace.

These upward jumps and spikes in risk seems to coincide pretty well with the credit crises and other negative economic and financial news. Of course, this isn't a careful study of the data, but I thought I would offer up a tiny bit of real world financial data analysis to readers of this blog.

Mimicking Soros, Dangers of Low Volatility, & Collusion in the Music Industry

I've noticed several interesting articles in The Economist magazine recently that are worth noting.

In his/her column, Soros on the cheap (April 4, 2007), Buttonwood makes the case for currency trading as a valuable addition to an investment portfolio. In particular, currency trading based on exchange rate models that take into account the 'carry trade' (an arbitrage technique which is similar to short selling), momentum, and purchasing power parity, have shown themselves to be profitable.

In last week's column, Sting in the tail: Is low volatility making the world too complacent about risk? (April 12, 2007), Buttonwood makes an even more convincing argument that instruments, practices, and institutions in the financial markets that leads to a relatively low volatility environment most of the time may wind up increasing 'tail risk' (i.e., extreme risk). Low volatility may be a 'false dawn' -- or perhaps even a cruel joke being played by the forces of market randomness -- that lull investors and traders into a false sense of security ... suckering people along into making bad financial decisions until catastrophe strikes.

Finally, in the March 29, 2007, 'Economics Focus' column, Silent orchestration: Can record companies act in concert, even without agreeing to do so?, The Economist examines the possibility that there is tacit collusion in the music industry by applying the logic of game theory. This type of analysis is very important to monopolies, antitrust, and competition laws & regulations. As the column points out, it is difficult to hold a cartel together (tacit or explicit), but, using game theoretic methods, it isn't impossible.