Volatility returns


How things can change in a month. At the start of February, volatility in equity, credit, interest rate and some foreign exchange markets was close to all-time lows - to the point where some were saying that a seismic downward shift in the price of the risk premium had taken place. Some attributed this, at least in part, to the growth of new hedging instruments such as credit derivatives.

Yet proponents of the cheaper risk theory fell quiet towards the end of the month, when volatility rose sharply across several asset classes. Equity volatility spiked upwards to an extent that it may pose problems for the increasing number of hedge funds and other investors that have shorted volatility during the past six months. Credit spreads also widened dramatically, meaning the raft of constant-proportion debt obligations, or CPDOs, in the pipeline may finally have been issued - but it looks bad for any transactions that priced just before the widening.

Yet it's the appreciation of the Japanese yen, combined with the modest rise in Japanese interest rates, that may cause the biggest headache, as counterparties are forced to offload their positions in equities and other asset classes to fund their liabilities in Japan. This, in turn, could prompt an appreciation of the currency and create a vicious circle for participants engaged in the yen carry trade (see page 8).

It's too early to call whether the asset price moves in late February are part of a major correction in the price of the risk premium, or merely the removal of some of the more speculative 'froth' from a number of bullish markets that have rallied for well over a year.

Naturally, increased volatility will provide good opportunities for traders to make money. But it will probably make life more difficult for corporate treasurers, many of which have reduced their hedging during the past year. But, as our cover story this month explains (on pages 14-16), that's a situation that major consumers of oil have faced for the past six months. That's why we asked a number of Asia's leading airlines how they have responded to this new challenge.

Meanwhile, some of the worrying regulatory issues that flared up in the past couple of months look set for a market-friendly resolution. Thailand seems likely to finally remove its awkward exchange controls (see pages 20-22), although it's not clear what long-term reputational damage this has caused the country. And the Reserve Bank of India (see page 4) may ease potential restrictions on swaptions and short-term currency hedges, although it looks set to maintain its proposed stringent controls on derivatives restructuring and appropriateness guidelines.

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe

You are currently unable to copy this content. Please contact info@risk.net to find out more.

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here