Stock market volatility: from empirical data to their interpretation

Wide swings in stock market prices in both Europe and the United States in recent years have revived the financial community’s interest in the concept of volatility. Even though investors frequently use the volatility of equity returns as an instrument for measuring risk, estimating volatility still raises problems and caution should be applied when interpreting it. However, an analysis of various available volatility indicators suggests that stock market volatility has shown an upward trend since 1997. This increase is most noticeable for technology, media and telecommunications stocks. Yet, when seen in the very long-term perspective, the current level of stock market volatility does not seem unusual or even extraordinarily high. Recent volatility patterns stem primarily from the lasting and substantial decline in stock prices from the highs reached in 2000, a large number of shocks affecting the financial economy, heightened uncertainty about geopolitical and macroeconomic developments and investors’ growing doubts about the quality of financial assets against the background of weaker corporate capital structures. In addition to these cyclical factors, this article examines how the way markets work may also have an impact on volatility. In particular, it looks at how widely held beliefs, or the « market consensus », can create price misalignments, which then lead to corrections. This usually results in large changes in prices associated with a high level of volatility. Finally, it looks at the role of the market participants’ operating environment, where there is a degree of uniformity in market risk management techniques and where institutional asset management is growing. This environment could in fact contribute to even greater uniformity in investors behaviours and fuel a rising trend in volatility.