The New Pattern of Market Volatility

The New Pattern of Market Volatility
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The New Pattern of Market Volatility

Economists, financial engineers and traders have long relied on the assumption that asset returns are “normally” distributed with correlations that are slow to change.




We see potential for a new paradigm in which a fat-tailed event to either the left or the right is as likely to occur as a non-event is.

Economists, financial engineers and traders have long relied on the assumption that asset returns are “normally” distributed with correlations that are slow to change. Markets were believed to be a bell- shaped curve.

But in a world of slower global growth and lower neutral monetary policy rates (we call it The New Neutral) over the secular horizon, plus the potential for more geopolitical developments, we see potential for a new paradigm in which a fat-tailed event to either the left or the right is as likely to occur as a non-event is. Now market distributions are more likely to be flat and correlations less stable.

In other words, the probability of small market moves that would otherwise be expected when considering a normal distributed variable will be reduced, and instead, larger moves may occur with higher probability. There are several factors contributing to this:

  • Changing and erratic central bank policy (including negative interest rates in some countries)
  • Divergence in global central bank policy – as bankers respond to regional economic conditions with the backdrop of a multi-speed global recovery
  • New global regulations
  • Less balance sheet availability from market-makers to provide liquidity (lower leverage ratios)
  • Global uncertainty over growth prospects
  • Increasingly narrow client mandates leading to “herding” action in asset classes

In our view, portfolio construction should be particularly mindful of hidden (or assumed) correlations and regime transitions, and traditional normal distribution assumptions for pricing risk are no longer fully valid. We believe active management that recognizes and adapts to such fat tails and changing correlations will be essential to seeking strong returns on capital – as well as the return of capital itself – going forward.

Read the full paper by William De Leon and Courtney Walker, HERE.

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PIMCO’s industry-renowned experts analyze the world’s risks and opportunities, from global economic trends to individual securities.

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