iBanker Market Update (Part 3): VIX Vapor Rub

An Under-Appreciation Of Risk

In the current marketplace buffeted by extraordinary amounts of liquidity both from the Fed and the ECB, it can be difficult to ascertain the real risk embedded in the current marketplace. The valuation and measure of risk is even more difficult when the sources of risk – the Eurozone, hard landing in China, fiscal chicanery here in the U.S. and the eventual removal of liquidity programs all have the potential to produce very, large exogenous shocks to the financial system.

Although imperfect, the VIX index has a profound impact upon the health of the marketplace and more importantly the direction of credit spreads and equity prices. The decline we have seen in the VIX over the last several months has, not surprisingly, resulted in superior performance. The VIX forward curve is illustrative in this regard with a decidedly upward slope as we head into the Fall.

Given the shape of the VIX forward curve and its historic tendency to actually underestimate risk, a real sense of caution is certainly warranted in the current marketplace.