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The New York Federal Reserve has waded into the debate over why the volatility of US equities remains at historically low levels, despite the plethora of potential risks for investors to consider.
It marks the first time the government body has opined on the topic of low volatility that has puzzled investors for much of the year.
The CBOE’s Vix Volatility index, a widely tracked measure of implied volatility, has sat well below its historical average of 20 for most of 2017.
In June, the Federal Reserve’s open market committee noted that, “a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.”
The New York Fed published a post on Monday evaluating some of the theories around why volatility is so low but stopped short of drawing any concrete conclusions. Still, it marks the first time the government authority has spoken publicly on the issue, with a follow up post on their blog Liberty Street Economics due on Wednesday.
“On one hand, we present a view suggesting that historical volatility may have been abnormally high, rather than current volatility being abnormally low,” said the authors of the blog post on Monday. “On the other hand, we find that estimates of the volatility risk premium are somewhat low, which is consistent with the view that investor risk tolerance has increased.”
The authors add that if the lack of volatility has led investors to ramp up leverage and increase the amount of risk they are exposed then a small shock to asset prices could force investors to rapidly sell assets, increasing volatility and creating a vicious cycle.
“This feedback loop creates risk endogenously, meaning that low volatility in itself can be a catalyst for high future volatility,” said the authors.
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