One of the final presentations given at the 31st Annual CBOE Risk Management Conference this year was an in depth discussion of volatility across asset classes. Brandon Bates, Portfolio Manager at BlackRock and Benjamin Bowler, Co-Head of Global Equity Derivatives Research at Bank of America Merrill Lynch co-presented the session titled Leveraging Cross-Asset Volatility Dynamics in Forecasting and Trading.
With the emergence of volatility as an asset class it appears that volatility across different market segment has been increasingly driven by common factors. It appears that volatility across different markets is moving more in sync, however there are still disconnects that occur which can aid traders and portfolio managers in forecasting market moves or identifying trading opportunities.
Bates began his part of the talk showing how equity index, interest rate, oil, and foreign exchange volatilities have tended to move together over the last 25 years. He noted that the volatility in the interest rate and foreign exchange markets now equals equity index volatility with respect to importance in the marketplace. He also stated that in normal market environments a move in one asset class will impact other asset classes. For example the equity markets lead other asset classes and equity, interest rate, and foreign exchange markets will lead energy. This cross asset class impact does not hold up during periods of financial market stress. A final and very important lesson was that real activity and business cycle indicators give clues about fundamental volatility.
Benjamin Bowler centered his discussion on the BAML Global Financial Stress Index (GFSI) which encompasses forty factors of risk across five different asset classes. He notes that over the last 14 years there have been 17 signals given by the GFSI with 11 of those signals identifying a global equity market pullback of at least 5%. He did mention that the last two signals in June 2013 and October 2014 both failed to be followed by a 5% equity market sell-off. A couple of key takeaways from this part of the presentation include that anyone trading volatility in a single asset class should be monitoring volatility in other major asset classes and that equity volatility rarely leads a major global risk-off event so when equity volatility moves higher it may present a good selling opportunity.