I was pleased to join BISAM’s EMEA team at yesterday’s Buy Side Risk conference, hosted by Risk.net in London. BISAM's Global Head of Risk, Dr. Boryana Racheva-Iotova led a captivated audience of asset managers through a lively discussion re: market turbulence, dislocations, liquidity through the lense of turbulent markets and the practical implications of all of the above on risk management processes and systems.
Boryana outlined an approach to measure market turbulence, based on the idea that “turbulence is the new normal” and volatile markets follow turbulent markets - in the sense that the "vol of vol" can be high when the vol is still low at absolute levels:
- Measure volatility of volatility
- Measure deviation from normality
- Measure “tail-fatness.” In normal markets, tail risk dissipates rapidly, but in turbulent markets we see tails decrease slowly. In other words, the probability of extreme events decreases more slowly in turbulent markets than normal markets.
Check out our recent blog posts to see examples of the BISAM Cognity Fat Tail Model applied to markets and specific names: http://blog.bisam.com/topic/risk-management
Boryana also noted the correlation between turbulence and “market puzzles,” or unexplained phenomena. She cited four particular examples and noted that all four out of four puzzles could be explained by incorporating higher than normal probability of extreme events or fat tails. Her research included these four “unexplained” phenomena:
- Equity premium puzzle
- Dividend puzzle
- Volatility smile
- Uncovered interest parity puzzle
And finally, with LIQUIDITY turning up as a discussion theme throughout the day’s discussions, Boryana’s presentation would not have been complete without a look at whether or not there is an association between market turbulence and liquidity. The short answer is YES:
- “The more volatile the markets, the more illiquid the assets.” And so if volatile markets tend to follow turbulent markets - as Boryana indicated at the start of her presentation - could signs of turbulence in particular markets be an early indicator of potential liquidity decreases in certain assets?
- All existing liquidity measures work in normal markets. The problem is that when markets are stressed, liquidity measures no longer reflect reality.
- Understanding systemic liquidity may allow managers to adjust measures to better define liquidity in turbulent markets.
I hope all of the above ideas leave you with room to ponder…and perhaps even drive you to start a conversation via the comments box below, which we always encourage!
P.S., if you attended the London conference and would like a copy of Boryana’s slides and the more detailed case studies, please drop us a line at [email protected]. And for those of you planning to attend next week’s Buy-Side Risk Conference in New York, you’ll have the benefit of hearing directly from Boryana when she gives a similar presentation.
Market Turbulence, Dislocation and Liquidity: https://attendee.gotowebinar.com/recording/6085373921955329538