Sunday, May 25, 2014

Great Moderation II

"For all my career, I've been trying to catch people after they do something horrible. For once in my life, I'd like to catch somebody BEFORE they do something horrible, all right?
--Doug Carlin (Deja Vu)

Nice follow-on (also another MV piece here) to our previous post on compression. A prior period of Fed-induced volatility suppression occured before the 2008 credit collapse. Many termed this period the Great Moderation.

Wanted to quote the author quoting a former Fed guy discussing the cause of the credit collapse:

"I have come to believe that the ultimate cause of the financial crisis in 2007-2009 was the great moderation. The financial system responds to volatility. When volatility declines the natural tendency is to use more leverage and to concentrate risk." [my emphasis]

What we are now experiencing is the Great Moderation II. The triggers will surely be different than last time, but when the system 'unmoderates' or decompresses, the observable characteristics will foster some deja vu. Deleveraging, vanishing liquidity, collapsing asset prices.

As a wise sage used to say during the first go-round, "Risk is high."

And getting higher with each day of compression.

position in SPX

1 comment:

dgeorge12358 said...

Empirical studies suggest that implied volatility indices provide reliable forecasts of short-term volatility, and the “fear gauge” appellation is widely accepted in light of the negative dynamic relationship with market returns.
~Center for the Study of Finance and Insurance