Wednesday, February 27, 2013

VIX, The End of Arbitrage and the Death of Volatility (VIX; VXX; VVIX)

I've read this post twice and have asked some smart people if an idea that it begat is feasible.
And yes the headline is the mating of Fukuyama and the BusinessWeek cover, probably making this the first spot that's ever happened.
I will be coming back to this and wanted to make sure I had the link on the blog.
Here are Izabella Kaminska and Christopher Cole at FT Alphaville:
A powerful convexity in short-term Vix futures
Before we comment about the strange behaviour of the Vix this week, we’d like to engage in a bit of a thought experiment.
There are two hypothetical scenarios that we’d like you to consider.
The first relates to the rampant nationalisation of everything:
What happens to market prices and volatility in an economy where government intervention becomes de rigeur every time prices misbehave?
The second relates to efficiency:
What happens to arbitrage opportunities and market prices in an economy where supply and demand logistics become ever better at anticipating supply and demand shocks, and they are also better at predicting and tracking general supply and demand trends? What happens when supply and demand data (of both goods and financial assets) becomes fully available to all in real-time and can be immediately cross compared with real-time data sourced from the internet of things — everything from internet-connected goods and devices to internet tracked logistic chains?
The answer to the first question, we propose, is a major reduction in volatility, while the answer to the second question, we dare to suggest, could be the end of arbitrage itself.
Neither of which are an exciting prospect for any market trader, who depends on both volatility and inefficiency to capture profits....
...Cole, via our inbox (our emphasis):
The behavior of the front of the VIX futures curve indicates that traders and investors have bought into the hope we have entered into a new low-volatility regime and that central banks will succeed in limiting all tail risks.

VVIX is the CBOE's volatility of volatility index.