Volatility and the Alchemy of Risk

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Volatility and the Alchemy of Risk: Reflexivity in the Shadows of Black Monday 1987

On October 19th, 1987 markets around the world crashed at record speed, including a -20% loss in the S&P 500 Index, and a spike to over 150% in volatility. Volatility and the Alchemy of Risk argues that the rising inflation was the spark that ignited the 1987 fire, while computer trading served as explosive nitroglycerin that amplified a normal fire into a cataclysmic conflagration. The multi-trillion-dollar short volatility trade, broadly defined in all its forms, can play a similar role today if inflation forces central banks to raise rates into any financial stress.

The Ouroboros, a Greek word meaning ‘tail devourer’, is the ancient symbol of a snake consuming its own body in perfect symmetry. In extreme heat, a snake is unable to differentiate its own tail from its prey, and will attack itself, self-cannibalizing until it perishes. 

The Ouroboros is a metaphor for the financial alchemy driving the modern Bear Market in Fear. Volatility across asset classes is at multi-generational lows. A dangerous feedback loop now exists between ultra-low interest rates, debt expansion, asset Volatility, and financial engineering that allocates risk based on that Volatility. Alchemy is the only way to feed our global hunger for yield, until it kills the very system it is nourishing.