Volatility index creator seeks to invent new tool to measure 'ambiguity'
Menachem Brenner discusses why VIX is low in time of uncertainty
KENJI KAWASE, Nikkei deputy editor
HONG KONG -- One of the hottest topics being discussed in global stock markets these days is volatility -- or rather, the lack of it. The most widely quoted benchmark, the Chicago Board Options Exchange's volatility index, better known as the VIX, has fallen below a reading of 10 during the past few weeks, approaching its lowest point since its inception in 1993.
The big question is why the index, which is considered to be a gauge of fear in the stock market, has been so low, particularly during a time of uncertainty, including the geopolitical risk posed by North Korea and the unpredictability of U.S. policy under President Donald Trump.
Some believe that the VIX no longer acts as a reliable forecaster of the stock market. But New York University professor Menachem Brenner, who pioneered the concept of the volatility index, said the role of the VIX is misunderstood even as he seeks to create a new tool to measure the different but relevant concept of "ambiguity," which could provide the missing piece to explain what is going on in the market.
In an interview with the Nikkei Asian Review in Hong Kong on May 5, Brenner said the perception that the VIX has "predictive power" is something promoted by "[news]letter writers and analysts, people who write to the clients." But for him, "I just use the word nonsense. It doesn't have predictive power."
Brenner was in Hong Kong to commemorate the 10th anniversary of a joint master's program on global finance involving NYU and the Hong Kong University of Science and Technology which he teaches.
According to the CBOE, the VIX is "an instantaneous measure of how much the market thinks the S&P 500 Index will fluctuate in the 30 days." Based on prices for call and put options of the S&P 500, the VIX rises when market participants feel volatility will be higher over the next month and falls when less volatility is expected. During the 2008 financial crisis when the market crashed, the index surpassed 80 in November 2008. But on May 8, it closed at 9.77, close to the all-time low of 9.31 reached in December 1993.
Brenner, who is best known for developing the forerunner to the VIX with the Israeli economist Dan Galai in 1986, explains that it is simply by definition that the volatility index goes down when the stock index goes up and vice versa. The stock and volatility indexes generally have a negative correlation and the VIX "will not tell you where the market will be going to go." S&P 500 reached a new all-time high on May 10.
New measurement tool
What he is now working on is to create a new gauge to measure the complicated concept of ambiguity so it can numerically capture the level of uncertainty that is not reflected in the VIX.
"Volatility alone doesn't explain expected returns. Higher volatility is higher risk, but that is not enough and you also need [to grasp] ambiguity," said Brenner. Just as the VIX acts as an indicator of volatility, "if there is an index, it will tell how ambiguous the market is [and that] will be another piece of information" for market players.
Brenner has been working on this project for the past five years with professor Yehuda Izhakian at Baruch College and it is now "at an advanced stage." Full details have not been revealed, but the veteran professor said the new index will be based on accumulated data of five-minute price movements of an exchange-traded fund that has tracked the S&P 500 over the last 20 years.
According to his study, "there were periods when the VIX was very low, but the ambiguity was high, and the other way around." He pointed to 2008 when the volatility gauge was at a historic high, but the ambiguity was "not extremely high." Asked about what the ambiguity index level would currently be, he said he has not calculated the figure, but "it would be relatively high. That would be my guess," perhaps implying that the S&P 500's bull run may not last long.
In discussing differences in market volatility by region, Brenner said the U.S. and European stock markets are relatively low compared with Hong Kong, but the Chinese markets are even "more volatile than Hong Kong."
According to his observations, the U.S. and European markets "pretty much go together" in terms of volatility, but the Shanghai market, where its own version of the VIX, called iVX, was introduced two years ago, acts more independently. "Many times, Chinese market goes its own way. It is different."