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The topic of stock market volatility has been on the lips of people every day as the trajectory of the crypto-currency bubble is cause for alarm, especially the volatility it is showing with its explosion and contractions being case for concern.
As friends and family have asked about this current bitcoin fever, an article about market volatility was a perfect topic to write about.
Volatility within the market is not a modern day phenomenon as it has been constantly prevalent in financial history and always raising its head. There are many causes of volatility which range from derivatives, leverage, media hype, heuristics, the health of the economy due to the business cycle, corporate corruption, and many more reasons.
This article will be looking the past and present term of volatility we are currently in and will simply discuss the root causes of high stock market volatility, using time points in history. As pointed out in previous articles, especially pertaining to the Black Swan Absorption article the causes of volatility can be divided in three categories of improvements in technology, improved historical recording, and improvement in education.
So to answer this question, volatility will be defined in the traditional form but building on the basis of how volatility is affected by time, access to the market, and behavioural aspects as outlined above in the perspective of all reasons for volatility that can be found in the three categories.
This then raises the simple question which is as follows, how does behavioural finance cause volatility in financial markets and how is this being witnessed right now at the end of ? The volatility of a stock price is a measure of how uncertain future price movements will be. As volatility increases, the chance that the stock will outperform or underperform will increase.
With volatility being an ever present factor that investors must take heed of, study into volatility is undertaken while the practioneers of minimising risk take great care to ensure their investments return a profit or at the very least dampen losses.
Avenues such as using derivatives and leveraging is a tried and tested technical means in which to squash risk as the diversification of risk or offsetting of risk occurs. Arbitrage, future contracts, options calls and puts, etc, are all tools for the intelligent investor to use as a risk control mechanism. From this technical and fama-esque perspective of the efficient market, we must also look at the behavioural aspects to investing that include observations of heuristics, herding, noise trading, etc.
This human irrationality that can creep into investors decision making in the form of a negative-positive mood spectrum which manifests itself in extreme panic to greed and anything in between can be seen to wreak havoc on markets from the past to the present in the form of bubbles rapidly inflating to bursting.
The other attributes that lead to volatility would be the streams of which noise via information are relayed to the public which can have a subconscious effect on them when it comes to decision making. Media hype, news of the economy, current economic environment, and improvements in technologies would all attribute the information that is bombarding people on a daily basis which influences their actions. Shiller asks the question why does volatility change from year to year and what should be done about it by government regulators?
The volatility of speculative markets succumbs to economic variables. Shiller tells us that EMH expects changes in volatility through fundamental means like speculative markets correspond to changes in volatility in real nonfinancial variables. However, other theories psychological would suggest that there is a relation between volatility in speculative markets and volatility of other macroeconomic variables.
These other variables would be that of herding, noise trading, and heuristics. Tversky and Kahneman the noble winners in for economics talk about prospect theory and loss aversion look at how humans look at losses and gains differently thus decision are made on perceived gains and not losses. Past bubbles have seen volatility in markets spike prices before they come crashing back down to earth.
Such bubbles would include Tulip-mania, South Sea bubble, the Great Depression, Black Monday in , Asian stock market crisis in , the dotcom bubble, and sub-prime mortgage crisis in Each of these bubbles and subsequent market crashes were all specific to certain type of main problem that filtered and fed into the overall economy and artificially inflated it. These specific bubbles have not been repeated due to a combination of better historical recording and improved technology, but these two factors along with incredible improvement in technology can also allow for new bubbles to be created.
The current bubble is the bitcoin bubble. Having first come across bitcoin in from the reddit website, the volatility of its current price is exhibiting all the classic symptoms of a volatility bubble. The technology until now has not been strong enough or widespread enough to have people partake in the bitcoin market but we are at that stage now.
Technological factors of improved ease of access, increased advertising campaigns for day traders to take part in the stock market, along with a bitter taste left in the mouths of the populous after a lot of people lost a lot of money with the financial collapse in , a lack of trust in government and government backed currency being at an all-time high, are the propellers for this unregulated crypto-currency fad.
Those trading in it are doing so with the intent of only holding the contract for Bitcoin with hopes to sell it off at a profit and not actually use it for transaction purposes.
This bitcoin bubble can have a spill over effect into other markets such as tech companies and companies that say they will begin to use like PWC thus adding to a positive pricing feedback loop that has no asset sustenance behind it. This current market of volatility can be viewed as a black swan as proposed by Nassem Taleb.
The aftershock of when the Black Swan is absorbed see my piece on Black Swan Absorption will have an immediate negative effect on those who are participating in the market and an effect on those who are not participating through economic knock on.
This negative effect will vary depending on individual participation. Black swans are waves of huge market volatility that hit the shore of market normality every so often through a new technology, security, or good market sentiment of the masses which reflects the mind-set of society. Nudge theory Robert Thaler will see investors on a hot streak positively reinforce their decision making in certain assets such as bitcoin on to other individuals and groups in an attempt to stimulate more demand for the asset thus pushing the price up even further.
Nudging is also present through media streams as the wild fire of popularity is permeating even mainstream media. The increased advertising on sites like YouTube to tempt people into participating in bitcoin is ludacris. As YouTube has 1.
This will increase volatility in this already highly volatile security which has seen massive percentage swings both positive and negative. The Bitcoin bubble just like all other bubbles before it will burst. It is only a matter of time of when it could happen.