Steven Poser is Managing Director in the Strategic Analysis and Market Data Group at NYSE Euronext. Steven is responsible for providing analysis...
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In part 1, part 2 and part 3 of our volatility series, we showed that depending on how you measure volatility, it is not really clear that the markets are truly more volatile now than they have been in the past. As Joe Mecane, CAO for U.S. cash markets for NYSE Euronext mentioned at SIFMA 2011, “"the perception of volatility -- and perception is what matters -- is high. But it's not necessarily unprecedented."
We could not agree more (at least partially because he was referring to analysis presented in these pages by yours truly, partially because your humble blogger reports into his organization, but more importantly, because he is correct). Our data show that intraday trading ranges are up since 2007, but much as we would like to be able to attribute this to one or two factors, we cannot.
But, What Causes Volatility?
We will cover our conclusions below, but there is little doubt that a lack of liquidity is a proximate cause of volatility. Those that love HFT, for example, point out that many HFT’s post liquidity and that should help dampen liquidity. Others correctly point out that all HFT is not liquidity provision and that some HFT may exacerbate imbalances. Others would like to blame various parts of Reg NMS, and yet others believe that ETFs are a factor in market volatility.
There have been some recent academic attempts to try and find measures that will forecast when there is risk of an event such as a flash crash. Some academic papers have focused on fragmentation, others on a measure known as VPIN (Volume Probability of Informed Trading). We simply note that when there are less posted shares available for the taking, while at the same time, liquidity demanding orders rise, the risk of large price moves increases.
By way of example, we found that shares posted on the NYSE on the most volatile days have tended to show measurably less depth than when the market is not quite as “animated”. Interestingly, we found that, especially near the inside, liquidity is less impacted, and that the more liquid the stock is, the less it is impacted as well.
Our review of volatility over the years highlights how much the markets have changed. Significant modifications to market structure, such as decimalization and Reg NMS have impacted how markets trade. Our basic findings show:
There is definitely more work to be done. For example, a study of market depth during different volatility regimes may help us to understand better why volatility changes and if HFT is stepping away when they are needed most.
We look forward to comments and suggestions from our readers.