The Volatility Paradox: Tranquil Markets May Harbor Hidden Risks
Published: August 17, 2017
Is today’s low volatility a sign of calm or a threat to financial stability — or both? This edition investigates the volatility paradox: the possibility that low volatility leads investors to behave in ways that make the financial system more fragile and prone to crisis.
- Volatility for most asset classes across the world fell below historical averages during the second quarter. In some cases, volatility is near all-time lows. Drivers of low volatility may include expectations that the long U.S. economic expansion and still-easy funding conditions will persist.
- Some institutional investors have adapted by increasing leverage and the use of yield-enhancing strategies.
- Shocks could produce procyclical responses if market participants use measures of realized volatility to manage the risk of their portfolios.