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Is market volatility set to strongly increase?


The UK's decision to leave the European Union caught Metaculus modestly by surprise. Consensus on "leave" was that there was a 32% chance. The Brexit, however, really caught the global financial markets by surprise. In the days prior to the vote, stock prices across the world were generally on the increase, with the S&P 500 peaking at 2112.93 at the close of the US Market on June 23rd, not far from its all-time high. And as measured by closing options prices on the index, demand for insurance against loss while the vote was well under way was not particularly high.

A few hours later, however, as it became clear that "Leave" would prevail, futures contracts on the S&P 500 went into free fall. At one point, in the midst of heavy overnight trading at the CME, they plunged nearly 6%. Market losses the next day were very heavy across the board. More than 2 trillion dollars in global stock market value evaporated. Viewed another way, each of the 17,410,742 "leave" votes generated a $115,000 loss in global market capitalization, a value that is nearly three times larger than the British per-capita GDP.

As usual, the market losses were accompanied by steep increases in volatility. The VIX index spiked to a high of 26.24, closing up 49.33% in a single trading session.

Impressive as that jump may sound, the forthcoming market disruptions implied by VIX are actually relatively modest. During the throes of the Financial Crisis in October 2008, a peak VIX print of 89.53 was observed. Roughly speaking, the value of the VIX index amounts to the expected one-sigma change in the S&P 500 index price during the coming year.

A look at the time series for the VIX shows that volatility tends to spike abruptly, and then decay in a roughly exponential manner over a period of months until the next shock hits. The VIX process is clearly not a random walk. Indeed, it certainly looks amenable to prediction... Before getting online with your broker, however, it pays to recall the worn adage that "a fool and his money are soon parted".

Will the VIX index achieve an intraday print above 40 prior to the 4:00PM close of the US equity markets on Friday July 29th, 2016?

Finance – markets

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