Monday, February 5, 2018

VIX index move was historic - The impact will be a negative feedback loop leading to equity selling from volatility rebalancing

The size of the move in the VIX index was large. The market is at the highest VIX level in years. We have to go back to 2015 to see this level. On a percentage basis, the change in the VIX was the single greatest increase over the last eleven years we looked at for comparison. It was a 77% increase from the previous day and more than 50% higher than the next greatest one-day increase.  Sorting the percentage changes gives another look at magnitude of the change. This was a historic day for volatility.

The market should be concerned about this move because so much money is now associated with volatility targeting and short volatility strategies. Take the simple case of volatility targeting. The increase in volatility will have to be offset with position selling to get portfolio volatility back to target levels. This will create a negative feedback loop. The selling will lead to more volatility and further selling. This should concern any investor. The effort of trying to employ better risk management will create more risk.

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