Market Instability in Historical Perspective

Stockholm (Ekonamik) – In a recent research note, Winton Capital asks “Are Markets Becoming More Unstable?” After considering a range of markets, the asset manager finds “that there is no evidence for increasing instability over the past 60 years”.

Assuming that “five-sigma events” – shifts that would happen once every thousand years if market returns were normally distributed – can be counted as “shocks” Winton Capital argues that the number of shocks in has not increased very much over time. These observations hold for equity, bond, currency, rates, various commodities and alternative investments markets.

Although it may have been more intuitive to display the quarterly shock count rather than the cumulative total, the data does appear to show a relatively stable rate of growth for the shock count. The only periods when the shock count seems to visibly deviate from a linear growth path is during the 1960s, 1979, the second half of the 1980s and in 2008. The shocks are more visible when shocks are measured by long- rather than by short-term volatility in returns.

Calamos Investments offers the opposing view. Using a different metric, the firm shows that there is an uptick in the number of daily moves of +/- 2% and +/- 3% since the 1950s. According to the research “a growing consensus holds that large daily swings, such as those that reappeared at the start of 2016, are more structural than temporary.” According to Calamos, technology and the increased interconnectedness and trading velocity it facilitates may be at the heart of the problem. “When investors decide to de-risk portfolios at the same time, the result can be like a game of musical chairs in which each investor seeks to avoid being the last to hold an unwanted asset.”

The narrative of technological disruption that Calamos provides is appealing and in synch with the zeitgeist. However, Calamos’s choice of measurement variable seems more arbitrary, which makes Winton Capital’s approach more convincing, by comparison. The fact that Winton’s conclusion appears to hold across markets and regardless of the time horizon over which the standard deviation is calculated is particularly appealing.

Unfortunately, the data presented by Winton Capital and by Calamos Investments is overwhelmingly focused on developed markets. The most popular article on this topic is a 1995 NBER paper by Bekaert and Harvey, but the data is old and the focus is on the causes rather than the trend. According to the research, there is wide variation across different emerging markets but some generalisations can be made. Political risk explains much of the volatility and financial market liberalisation seems to decrease volatility.

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