Market Risk Monitor – July 2017

Jul 20, 2017
By BlackRock

A benign risk picture


Our metrics show a risk picture that remains particularly benign. This now appears to be a well-established pattern. Across most asset classes and most geographies both implied and realized volatility have been low, sometimes very low, and in general investors have been rewarded for taking risk. On occasion, this calm has been interrupted by sharp episodes of much higher implied volatility, accompanied by negative returns to most risky assets. However, these more difficult episodes have been short lived, and followed on each occasion by a return to the post-crisis calm. But how sustainable is this current low volatility environment and does it represent – as some are arguing – a source of risk in itself?

Market Risk Monitor

Ed Fishwick and Tara Sharma from the Risk & Quantitative Analysis Team discuss whether the current low volatility environment is a source of risk in itself.

A longer-term phenomenon

Leaving aside the somewhat paradoxical aspect of an argument suggesting that low implied risk is itself a risk, it is worthwhile reflecting on the likely causes of this low volatility environment in a broader context. Analysis of the long-term US stock market data (1871 till the end of April 2017) provided by Robert Shiller suggests that low volatility regimes are far more common than high volatility regimes, and that low volatility has often persisted for extended periods. Furthermore, it seems clear that high volatility is, unsurprisingly, strongly associated with elevated economic risk.

That said, we still see a variety of geopolitical and economic concerns that have the potential to upset markets and cause risk episodes of the type seen previously in this low volatility environment. However, for a shift to a sustained high volatility regime to occur more may be required than a temporary focus on one or other of these widely understood event risks.