Volatility and tail risk - The need for liquidity

Graham Capital provides some helpful charts on the current volatility environment in its paper, "Tail risk as a structural feature of modern markets." The MOVE index of bond volatility has shown significant increases since 2022, following a prolonged period of benign movements during the post-global financial crisis (GFC) period. The VIX has also shown an extended period of volatility. There is an ebb and flow with volatility, but the greater concern is cross-asset volatility, which indicates that we have seen more spikes in volatility over the last five years. These spikes are particularly hazardous for investors, especially when they occur frequently.  

Graham argues for adaptive risk management frameworks that combine quantitative and discretionary approaches through both top-down and bottom-up approaches. These approaches include stop-loss and profit-taking. We agree in principle that this is an adjunct to risk management; however, it is not clear exactly how it should be implemented. One beneficial idea is that under a high-risk environment, there is a strong need for liquidity. Liquidity provides embedded optionality through allowing investors to change direction during periods of high uncertainty. When there is a breakdown in correlation and higher volatility, liquidity allows investors the chance to pivot, even if it's just to cash.