It’s known as the fear index and investors watch it for signs of impending stock market crashes.
Until last week the Vix was among the calmest features of the international money markets. Then suddenly it exploded into life to register the largest one-day rise in its history.
The Vix is a measure of how fund managers assess the economic, political and financial pressures affecting companies listed on the US stock market and the extent to which shares will rise or fall over the next 30 days. Its proper name is the CBOE volatility index and it tracks the S&P 500, which is the broadest and most respected measure of the value of America’s largest companies. It is run by the Chicago Board Options Exchange, hence “CBOE”.
For 18 months the Vix index had ignored the ebb and flow of financial news. Hardly a week went by in 2017 when someone in the City didn’t comment on the Vix and marvelled at how it had remained low for such an unfeasibly long period.
The general rule of thumb has been that when the Vix index rises above 30 it indicates serious unease, and a reading above 40 heralds a crisis. Its long-term average is about 20. The biggest jumps came during the 2008 financial crash, when the index rose above 90, and in 1987, following the Thatcher/Reagan deregulation of financial markets, when it reached 150.
Last week it rose from around 10 points to above 30 in response to concerns that the cheap money driving economic growth may be restricted this year more than previously expected. Briefly it soared near 50 before falling back to below 30.
For some time economists have agonised over whether the Vix is a portent of 2008-style mega-crashes or has become corrupted by the demands of investors who not only watch it intensely for signs of trouble, but have placed bets on the ups and downs of the index itself.
There isn’t much money riding on the Vix. It amounts to around $8bn. Set that against the $23 trillion value of the S&P 500 and it is easy to dismiss the distorting effects of those using the Vix as a financial instrument. However, so many financial measures have been corrupted over the years, or made redundant as a measure of financial stress, that it must be legitimate to question it.
The Baltic Dry index was another such measure; it was credited with signalling the 2008 crash only to fall out of favour once investors began to bet on it.
That index documented spare shipping capacity, and therefore the cost of sending containers of dry goods, iron ore and metals around the world. On a long view, it has barely flickered since 2010. Last year it was bought by the Singapore Exchange; this month, reforms to it were agreed. Without going into too much detail, smaller ships have been taken out of the index and monster-sized tankers given a greater share.
To illustrate how an index can be distorted, the Baltic Dry has suffered from the trend for South Korea to manufacture large ships very cheaply and at an alarming rate, regardless of demand. This has allowed ship owners to keep spare capacity in dock during the bad times and float it back into service when trade picked up. In such a market, spare capacity is less likely and price volatility becomes non-existent.
The Vix may suffer from a feedback loop that stems from investors reporting low volatility because they have bet on low volatility. It is unproven whether the Vix is under the influence of anything but the genuine forecasts of investors who are part of the club that contribute their views. Nevertheless, it wouldn’t be the first such measure to be corrupted.
The Libor index recorded the interest rate that banks in London charged each other and in this way provided the basis for mortgage rates in the UK. The rate was arrived at by asking bank staff how much they expected to pay.
Bank staff conspired to rig the rate and in doing so bagged millions of pounds in bonuses. The £5.5tn of foreign exchange trades made per day were based on prices set each afternoon in a 60-second window. Traders found that if they bought and sold currencies in large amounts in this brief period, they could influence the price.
The scandal was uncovered and in 2015 prompted regulators to impose large fines on a group of banks.