Volatility regimes are decisive for most investment approaches—hedge funds especially.
Volatility regimes are decisive for most investment approaches—hedge funds especially. They are determined by a wide set of drivers that influence one another. It takes a coalition of drivers to alter volatility regimes, requiring a 360° analysis to anticipate volatility trends. Upstream, macro volatility is paced by inflections of the business cycle, dispersion across world economies, swings in monetary policies and credit conditions, as well as by tail or geopolitical factors.
Macro volatility reverberates at a micro level, affecting households and corporate fundamentals. In turn, both households and companies accumulate actual and/or perceived risks and imbalances (through leverage, shifting income/profits, etc.) which finally spread to market volatility. As it became a key input for risk taking (setting leverage and asset allocation targets) and an asset class in and of itself, volatility has also become one of its own movers in a circular reference. When direct and indirect short-volatility exposures pile up, investors become vulnerable to non-linear deleveraging and sudden asset re-correlation known as gamma and correlation risks. Several volatility flash crashes serve as reminders.