1	Stock Volatility During the Recent Financial Crisis G. William Schwert http://schwert.ssb.rochester.edu/GWS110718.htm
2	From Presidential Debate, October 7, 2008
3	What is market volatility? Standard deviation of rates of return to broad market indexes Following plots show: Changes in DJIA from 1895-2011 Affected by growth in the level of the index Percent changes in DJIA (rates of return, ignoring dividends) from 1895-2011 Rolling annualized standard deviations of rates of return to DJIA from 1895-2011
4	So what was candidate Obama talking about? Standard deviation of rates of return to broad market indexes Following plots show: Changes in DJIA from 1895-2011 Affected by growth in the level of the index Percent changes in DJIA (rates of return, ignoring dividends) from 1895-2011 Rolling annualized standard deviations of rates of return to DJIA from 1895-2011
5	Looking at the absolute scale of stock indexes is very misleading . . . The sixty largest changes in the DJIA have been within the last 12 years The only exception among these sixty days is 10/19/1987
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8	Looking at the percent change of stock indexes is relevant . . . This measures the rate of return on the investment i.e., how many more dollars you would have at the end of the day if you invested $100 at the beginning of the day The nine of the sixty largest percent changes in the DJIA have occurred between 2008-2010 five were positive
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11	How to lie with statistics . . . - focus on very recent history Newspapers often focus on the last few years in discussing current conditions On this basis, people would think stock volatility is unbelievably high in the past year or so . . . This is misleading when viewed from the perspective on the longer history we have available to us Compare the plots of rolling standard deviations from 2004-2011 versus the plot from 1895-2011 . . . Good news is that things seem to have settled down a bit now (compared to 3 years ago)
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14	Stylized Facts/Questions: A very long-term view! Market-level volatility has been remarkably stable over time Data back to 1802, covers many wars, financial crises, depressions/recessions Also, major changes in the composition of the US economy Mainly banks, insurance companies, canals in early 1800s Railroads started being important after 1834 Great Depression is the most notable period of prolonged high volatility
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16	Forecasting volatility: Important because of recent high volatility Derivatives give us tools CBOE reports implied volatility for S&P 500 options (VIX) for several maturities They have also started trading futures contracts on implied volatility
17	Term structure of implied volatility: Things will settle down . . . Looking at the term structures from 2000-2010, they were pretty flat (i.e., similar forecasts for all horizons) until October 2008 The big spikes in volatility in Fall 2008 led to a sharply declining forecast of future volatility Things are now back to more normal patterns
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27	The CBOE now trades a futures contract on VIX Looking at the longest future maturity (typically about 9-10 months) Futures value of VIX peaks at 43% in mid-December 2008, and now has returned to around 25% Even at the worst of the liquidity crisis, traders were not expecting the spike in volatility to last long or be as bad as it was briefly in the Fall of 2008
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29	Sometimes Sectors Drive Market Volatility: Technology in 2000-2002 Next figure shows the implied volatility series published by CBOE with ticker symbols VIX (S&P) and VXN (Nasdaq) VXN is much higher, especially in 1998-2002; similar since mid-2007
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32	Actual Volatility of Technology Stocks Next figure shows historical volatility for: the Datastream US Technology portfolio, since 1973 The “DOT.COM” period from 1998-2002 was a period of very high volatility Not just internet and computer stocks, biotech too Increased substantially in 2008-2009, but not like financial stocks
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34	Was the 2008 Credit Crisis a Finance “Bubble”? Next figure shows historical volatility for: the S&P 1200 Financial portfolio, and the Datastream US Financial portfolio, since 1973 They all move together, increasing modestly during the Technology “bubble” from 1998-2002 Increased substantially in 2008-2009 during the liquidity crisis
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36	International Volatility Following figures show historical volatility for: FTSE All Shares Index in London since 1968 the Nikkei 225 and Topix Indexes in Japan, since 1950 They all move together, increasing modestly during the Technology “bubble” from 1998-2002 Increased substantially in 2008-2009 during the liquidity crisis
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39	Links to Real Economic Activity: The Unemployment Rate During the Great Depression, the unemployment rate and stock volatility moved closely together Not true since that time While Candidate/President Obama’s statement alluding to the Great Depression was accurate for stock volatility, it is far off for the unemployment rate Unemployment since 2008 has not been greater than it was from Sept-82 through June-83
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41	Summary Market-level volatility often rises after prices fall Recent poor performance of the market is consistent with the higher levels of volatility [counter-cyclical] Inflation of index levels exaggerate perceptions of increased volatility
42	Summary Because volatility is easy to see in real time, it has become a major focus of the news media and politicians and, therefore, of main street America For most people, who should be buy-and-hold long-term investors, short-term burst of volatility should not be a cause of concern
43	Summary Structural problems in the economy often cause companies, employees, and politicians to blame “Wall Street” In an internationally competitive world, high-paying (unionized) manufacturing jobs for relatively low-skilled workers are going to continue to disappear in the US
44	Summary Similarly, perhaps well-intentioned efforts to extend home ownership to people who would not traditionally qualify for mortgage loans led to risk-taking in real estate markets that was either ignored or not well-understood
45	Summary Until market forces are allowed to set competitive wage rates in industries and market-clearing prices for housing, the stories about unemployment in states with expensive unionized labor and still over-priced houses will continue Government programs to delay these adjustments just prolong the pain . . .