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The first measure is long term, focusing on very limits of capitalization, the second short term, focusing on stock price volatility in the near future. Perhaps there is reason for them to correlate, though that reason doesn’t seem obvious on the surface.
Thank you Jonathan for this clarification.
Volatility appears to follow a different dynamic. Investopedia notes: “The [volatility index] generally rises when stocks fall, and declines when stocks rise.” This seems like common sense: when stocks go up, people are more likely to hold onto them then to sell. It also makes quantitative sense. If the magnitude of change is measured as a percentage, then when stock prices are higher, the same absolute change will register as a smaller rate of change, and therefore less volatile. I may be misinterpreting Investopedia’s claim, but its possible that the volatility index may simply be measuring a statistical regularity, and may have only a tenuous claim to measure ‘systemic’ phenomena. Another thing to note is that larger firms tend to have less volatile prices than smaller firms, likely for the same reasons. People tend to trust, and therefore hold onto higher value stocks and the same absolute change in price registers as a smaller percent rate of change for the larger firm.).
Thank you for your input, James.
I think you are right that volatility cannot be always related to systemic phenomena (and as your Master thesis’ findings illustrate). Furthermore, traders can purposively provoke volatility to increase their share of the cake.
However, in the other way around, the relation could be true (systemic phenomena threatening power -> increased volatility), I think. I’ve found different papers suggesting at least that major political events create volatility. For example, this one on “political shocks and asset prices” finds that:
With respect to the size of these effects, the most significant increase in post-event volatility is associated with irregular government turnovers (coup d’états, presidential death, and resignations). […]. National elections are also a source of considerable financial volatility. In the case of nominal returns, the arrival of post-electoral news is associated with a 40 percent increase in volatility. The effect of electoral outcomes on asset prices is comparable to how the market reacts to changes in the country’s economic stewardship. Whenever the person in charge of the economy changes, regardless of whether the country’s administration changes or not, the post-event volatility ratios are also positive and statistically significant.
But I agree that it is definitely something different than N&B’s “systemic fear”. In this case the capitalization ritual does not seem broken.
