Volatility Voodoo

Kent Osband writes that unfortunately, most of the pious pronouncements about financial market volatility are nothing more than voodoo. Disciples turn into zombies, endlessly muttering “irrational exuberance”, “unbounded moments”, “GARCH behavior”, “fractional Brownian motion”, and other mantras of despair. Intimidated, few non-disciples dare to even look for simpler, less superstitious explanations of excess vol.

Unfortunately, most of the pious pronouncements about financial market volatility are nothing more than voodoo.

 

You don't have permission to access this content

 

How do I love thee? Let me count the ways.
I love thee to the depth and breadth and height
My soul can reach, when feeling out of sight. . .
I love thee with the passion put to use
In my old griefs, and with my childhood’s faith.

When I read these words, written over a century and a half ago, I marvel at how presciently Elizabeth Barrett Browning anticipated the modern enthusiasm for financial market volatility. For some, vol is a fantastic lottery, providing an adrenaline rush most Powerball players can only dream of. For others, it’s proof of man’s inherent wickedness and/or the inherent injustice of life.

Even scientists are enthralled. Economists use the allegedly excess volatility of market prices relative to fundamentals
to demonstrate the deep-seated irrationality of rich investors. Fellow academics, reassured that their shortcomings
in wealth vouch for their smarts, heap accolades on them. As for derivatives modelers, unevenly excess vol is a goldmine: the greatest boost to the curvefitting industry since Ptolemaic epicycles.

Unfortunately, most of the pious pronouncements about financial market volatility are nothing more than voodoo. Disciples turn into zombies, endlessly muttering “irrational exuberance”, “unbounded moments”, “GARCH behavior”, “fractional Brownian motion”, and other mantras of despair. Intimidated, few non-disciples dare to even look for simpler, less superstitious explanations of excess vol.

 Logged-in members can download the article by clicking the link under all the “Related Posts” below. If there isn’t a link then you aren’t logged in! To log in or register visit here.

Related Posts

What is Implied by Implied Volatility? Word and concept Implied volatility is not just a word or a concept. As a word, what is implied by implied volatility – what “implied volatili...
Introduction to Variance Swaps The purpose of this article is to introduce the properties of variance swaps, and give insights into the hedging and valuation of these instrument...
Volatility: Time and Black–Scholes–Merton The formalism of Black–Scholes–Merton knows of no such thing as the past or the future. When it models the stochastic process of the underlying as...
The Volatility Smile Problem: From Within The Smile Problem is not a falsification of the BSM model ... The smile problem is produced from inside. In the following, I will say what the smi...
Order Statistics for Value at Risk Estimation and ... We apply order statistics to the setting of VaR estimation. Here techniques like historical and Monte Carlo simulation rely on using the k-th heaviest...
Poker as a Lottery Doyle Brunson , two-time winner of the World Series of Poker main event, has likened a poker tournament to a lottery in which more skilled players...
Building Your Wings on the Way Down Ray Bradbury famously defined “living at risk” as jumping off a cliff and building your wings on the way down. Too many financial risk managers wh...
Internal LGD Estimation in Practice Driven by a competitive market and motivated by the new Basel Capital Accord (Basel II), banks have put a lot of effort into development and impro...
Volatility Voodoo
Kent Osband writes that unfortunately, most of the pious pronouncements about financial market volatility are nothing more than voodoo. Disciples turn into zombies, endlessly muttering “irrational exuberance”, “unbounded moments”, “GARCH behavior”, “fractional Brownian motion”, and other mantras of despair. Intimidated, few non-disciples dare to even look for simpler, less superstitious explanations of excess vol.
0311_osband