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Transcript of ©R. Schwartz Volatility: Markets at Risk Slide 1 Bob Schwartz Zicklin School of Business Baruch...
Slide 1 ©R. Schwartz Volatility: Markets at Risk
Bob SchwartzBob SchwartzZicklin School of BusinessZicklin School of BusinessBaruch College, CUNYBaruch College, CUNY
WFE Workshop on Market Structure & Statistics
Paris, December 1-2
Slide 2 ©R. Schwartz Volatility: Markets at Risk
Volatility and Risk
• Central importance in Finance
• Risk has a well defined meaning
• Risk is not the only contributor to volatility
Slide 3 ©R. Schwartz Volatility: Markets at Risk
Uncertainty
• We do not know the probability distribution
• We might not even know all of the outcomes
• Uncertainty is a major contributor to volatility
• We have not paid sufficient attention to uncertainty as a cause of volatility
Slide 4 ©R. Schwartz Volatility: Markets at Risk
A Little Red or Black Animal That Can Crawl Around and Annoy Us
Individually so dumb, collectively very smart
An Ant
Slide 5 ©R. Schwartz Volatility: Markets at Risk
Security Traders
Individually very smart, collectively so dumb
Slide 6 ©R. Schwartz Volatility: Markets at Risk
Why So Dumb?
• There is a great deal about volatility that we do not understand
• There is quite a bit that we thinkthink we understand but don’t!
That’s dangerous!
Slide 7 ©R. Schwartz Volatility: Markets at Risk
High Intra-day Volatility
• Really high volatility has been with us for over a year
• I do not mean long-run vol (weeks, months, or years) but…
• Intra-day vol!
• Price changes of 1%, 2% or more are common
• A 1% daily price change 250% annual change!
• What does intra-day volatility look like?
Slide 8 ©R. Schwartz Volatility: Markets at Risk
INTRA-DAY VOLATILITYNYSE
October - December 1999
0.00%
0.40%
0.80%
1.20%
1.60%
Hal
f-Hou
r V
olat
ility
The First 1/2 Hour
Slide 9 ©R. Schwartz Volatility: Markets at Risk
INTRADAY VOLATILITYNASDAQ
October - December 2000
0.00%
0.50%
1.00%
1.50%
2.00%
Ha
lf-H
ou
r V
ola
tili
ty
The First 1/2 Hour
Slide 10 ©R. Schwartz Volatility: Markets at Risk
January - May 2000
0
0.5
1
1.5
2
2.5
3
8:00-8:30
8:30-9:00
9:00-9:30
9:30-10:00
10:00-10:30
10:30-11:00
11:00-11:30
11:30-12:00
12:00-12:30
12:30-1:00
1:00-1:30
1:30-2:00
2:00-2:30
20:30-3:00
3:00-3:30
3:30-4:00
4:00-4:30
Ha
lf-H
ou
r V
ola
tili
ty
INTRADAY VOLATILITYLONDON STOCK EXCHANGE
The First 1/2 Hour
Slide 11 ©R. Schwartz Volatility: Markets at Risk
INTRADAY VOLATILITYEURONEXT PARIS
January - May 2000
0
0.2
0.4
0.6
0.8
1
1.2
1.4
9:00-9
:30
9:30-1
0:00
10:00
-10:30
10:30
-11:00
11:00
-11:30
11:30
-12:00
12:00
-12:30
12:30
-1:00
1:00-1
:30
1:30-2
:00
2:00-2
:30
2:30-3
:00
3:00-3
:30
3:30-4
:00
4:00-4
:30
4:30-5
:00
Clos
ing Call
Ha
lf-H
ou
r V
ola
tili
ty
The First 1/2 Hour
Slide 12 ©R. Schwartz Volatility: Markets at Risk
INTRADAY VOLATILITYDEUTSCHE BÖRSE
January - May 2000
0
0.2
0.4
0.6
0.8
1
1.2
Ha
lf-H
ou
r V
ola
tili
ty
The First 1/2 Hour
Slide 13 ©R. Schwartz Volatility: Markets at Risk
My Current Nasdaq Study
• 52 large cap Nasdaq firms
• Time period: Feb 04 and Feb 05
• We examined per day:
390 1-minute intervals (9:30-16:00)
30 10-second opening intervals (9:30-9:35)
30 10-second closing intervals (15:55-16:00)
• Volatility measured by high-low range for the interval
““The Quality of Price formation at Market Openings & Closings:The Quality of Price formation at Market Openings & Closings:Evidence from the Nasdaq Stock Market”Evidence from the Nasdaq Stock Market”
Michael Pagano, Lin Peng, and Robert SchwartzMichael Pagano, Lin Peng, and Robert Schwartz
Slide 14 ©R. Schwartz Volatility: Markets at Risk
Nasdaq Volatility Differences Between Feb 2004 and Feb 2005
One-minute Volatility
wr ange
0
20
40
60
i nt er val
0 30 60 90 120 150 180 210 240 270 300 330 360 390
60 bps60 bps Feb 2004 (Pre-Calls) Feb 2004 (Pre-Calls)r ange
0
20
40
60
i nt er val
0 30 60 90 120 150 180 210 240 270 300 330 360 390
60 bps60 bps Feb 2005 (Post-Calls) Feb 2005 (Post-Calls)
Slide 15 ©R. Schwartz Volatility: Markets at Risk
r ange
0
10
20
30
40
i nt er val
0 6 12 18 24 30 36 42 48 54 60
Nasdaq Volatility DifferencesBetween Feb 2004 And Feb 2005
10-Second Volatility
r ange
0
10
20
30
40
i nt er val
0 6 12 18 24 30 36 42 48 54 60
40 bps40 bps Feb 2004 (Pre-Calls) Feb 2004 (Pre-Calls)5 Min After
Opening5 Min Before
Close
40 bps40 bps Feb 2005 (Post-Calls) Feb 2005 (Post-Calls)5 Min After
Opening5 Min Before
Close
Slide 16 ©R. Schwartz Volatility: Markets at Risk
What Explains Accentuated Vol?
• Reason One: Price discovery
• Reason Two: Liquidity creation doesn’t just happen
• Volatility in opening minutes: Price discovery
• Volatility in closing minutes: End of day effects
• Volatility at any time of the day: One-sided markets
Slide 17 ©R. Schwartz Volatility: Markets at Risk
Reason One: Price Discovery
• A difficult process
• Especially complex when some investors are influenced by what they see other investors doing…
• That is when we get information cascades
Slide 18 ©R. Schwartz Volatility: Markets at Risk
Reason Two: Liquidity Creation
• Markets are generally two-sided under a spectrum of conditions
• But sometimes they are one-sided….
• Liquidity dries up on one side of the market and volatility spikes…
• Information cascades…
• And, when prices head south, who wants to catch the falling knife?
Slide 19 ©R. Schwartz Volatility: Markets at Risk
What To Do About It?1. Market Structure
• Transparency vs. opacity
• Consolidation vs. fragmentation
• Temporal consolidation and call auctions
• Circuit breakers and volatility interruptions
• Stabilization programs
Slide 20 ©R. Schwartz Volatility: Markets at Risk
Corporate Stabilization Programs
• A corporation can set up a STABILIZATION FUND
• Doing so is VOLUNTARY
• The fund is RUN BY A FIDUCIARY
• Shares and capital are put into the fund
• Shares are purchased in a falling market but…
• Shares are also sold in a rising market
• All orders are entered at pre-announced price points in pre-announced sizes according to an algo formula that is common knowledge
• Orders are executed in call auction trading only
• I proposed this in Fall 1988. I still believe in it.
Slide 21 ©R. Schwartz Volatility: Markets at Risk
• We have been hit by tidal waves of volatility
• Regulation is indeed needed
• But it must be appropriate
• Will it be?
• One thing is for sure…
What To Do About It?2. Regulatory Structure
Slide 22 ©R. Schwartz Volatility: Markets at Risk
The financial turbulence of 2008 has given us all a great deal to think about!