Improved structure of markets, liquidity and better communication responsible for low volatility

Developments in financial markets that have reduced volatility include greater liquidity and an increase in the supply of options such as hedge funds, investment banks and pension funds.

Monetary policy has also played a role – the report emphasises the importance of the trend among central banks for gradualism, or frequent and small policy changes, communication about policy and overall improvement in the operational framework.

The paper, which examines market volatility since 1970, finds that low price volatility has been the most striking feature of market behaviour in recent years in both industrial and emerging market economies. “Volatility has been low for a prolonged period simultaneously across different assets and markets,” the report stated.

The countercyclical nature of volatility and the “Great Moderation” (less volatile output growth) are both taken into account to explain the length of the recent period of stability, and the paper acknowledges that some volatility could return if investors find a more attractive alternative to options.

However, the report argues that the reduction in volatility appears to be as a result of structural changes, and therefore may be permanent. The report refutes the idea that stability is not simply an absence of financial shocks: “The evidence summarised in this report is not supportive of the so-called ‘good luck hypothesis’.”

Click here to see the report in full on the BIS website.

BaselAlert.com
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