Money, Banking and Financial Markets

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Commentary

 
 
Posts tagged Options
In Defense of Regulatory Diversity

Guest post by Lawrence J. White, Robert Kavesh Professor in Economics, NYU Stern School of Business

The U.S. regulatory landscape--especially with regard to financial regulation—is maddeningly complex.  It is easy to make a case for a drastic simplification, and the authors of this blog have done so here. But there is value in diversity—including regulatory diversity. Consequently, with regard to the regulatory framework, as is true of most other areas of political economy, we need to consider the costs as well as the benefits of any proposed changes.

Let’s start with the undeniable complexity of U.S. financial regulation: Consider the following array of agencies and jurisdictions (an alphabet-soup glossary appears at the end)...

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Steve Cecchetti and Kim SchoenholtzFinancial innovation, Regulation, Multiple regulators, Regulatory complexity, Regulatory diversity, Regulatory framework, Regulatory structure, Regulatory error, Redundancy, Federalism, Exchange-traded product, Futures, Options, Basel II, MMMF
Black Monday: 30 Years After

On Monday, October 19, 1987, the Dow Jones Industrial Average plunged 22.6 percent, nearly twice the next largest drop—the 12.8 percent Great Crash on October 28, 1929, that heralded the Great Depression.

What stands out is not the scale of the decline—it is far smaller than the 90 percent peak-to-trough drop of the early 1930s—but its extraordinary speed. A range of financial market and institutional dislocations accompanied this rapid plunge, threatening not just stocks and related instruments (domestically and globally), but also the U.S. supply of credit and the payments system. As a result, Black Monday has been labeled “the first contemporary global financial crisis.” And, a new book—A First-Class Catastrophe—narrates the tense human drama that it created for market and government officials. A movie seems sure to follow.

Our reading of history suggests that it was only with a great dose of serendipity that we escaped catastrophe in 1987. Knowing that fortune usually favors the well prepared, the near-collapse on Black Monday prompted market participants, regulators, the lender of last resort, and legislators to fortify the financial system.

In this post, we review key aspects of the 1987 crash and discuss subsequent steps taken to improve the resilience of the financial system. We also highlight a key lingering vulnerability: we still have no mechanism for managing the insolvency of critical payment, clearing and settlement (PCS) institutions....

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Steve Cecchetti and Kim SchoenholtzStock market, Financial instability, Crash, Volatility, Clearing, Settlement, Clearing and settlement systems, Payments system, Leverage, Counterparty risk, Financial market utility, FMU, First-mover advantage, Margin, Margin call, Dodd-Frank Act, CHOICE Act, Derivatives, Clearinghouse, Liquidity, Long position, Short position, CAPE ratio, Futures, Options, Collateral, Central bank independence, Lender of last resort
The VIX: The only thing to fear is the lack of fear itself

The VIX has been called the fear index.  That is, it is a measure of the uncertainty and risk that investors see over the near future (specifically, the next 30 days).  Constructed from options on S&P500 index futures, the VIX is technically a gauge of what is called implied volatility. (For a definition, see the brief note at the end of this post.)

The technicalities are not all that important, as the VIX and similar options-based measures of implied volatility (like the DJIA Volatility Index shown with the VIX in the chart below) track financial conditions pretty well. When implied volatility is low, conditions are relatively accommodative; when it is high, they are restrictive.  Today, volatility is unusually low... 

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Steve Cecchetti and Kim SchoenholtzVIX, Implied volatility, Reaching for yield, Options, Leverage, Value at risk