Volatility has returned to financial markets this year, snapping the tranquility of 2017 that allowed asset classes further out the risk spectrum to flourish.
The daily swings are getting larger, and more frequent, compared to what market participants expect.
From Morgan Stanley’s European Cross-Asset Markets team, it shows the number of price movements across global stocks, rates, currencies and commodities greater than three-standard deviations away from what was implied by options markets before each event occurred.
Extremely rare, in other words.
“2017 was remarkable,” Morgan Stanley says.
“Despite low levels of volatility that made the bar for a large move relatively low, few occurred.
“2018 is very different, with more large price swings versus market expectations than any post-crisis year.”
Morgan Stanley says tightening monetary policy settings and geopolitical risks explain part of this uptick, but not all of it.
“We think it is also suggestive of constrained market liquidity, with growing markets supported by the same limited dealer balance sheet,” it says.
“This isn’t the problem of a single asset class. It’s everywhere.”
Given the increase in unusually large daily moves relative to expectations this year, Morgan Stanley says investors, especially in options markets, should be careful extrapolating what was seen in 2017 for their investment decisions in the months ahead.
“Investors should be cautious about using the low realised volatility environment of 2017 as a parallel for the year ahead,” it says.
“Options markets should at least price in a steeper skew across asset classes and especially so in a less liquid asset class like credit.”
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