Tuesday, January 02, 2007

Beware the tranquility

Global equity volatility and Indian equity volatility is low. The blue line is the implied volatility off the S&P 500 options market; the red line is the backward looking rolling window volatility of Nifty (width = 66 days).

I wrote an article in Business Standard titled Beware the tranquility. In this, I worry that the world could undergo a `phase transition' and jump back to a configuration of high volatility, high risk premia and high liquidity premia. This is linked to the arguments made by Raghuram Rajan in June 2006 where he draws a link between low interest rates and the remarkable decline in risk premia and liquidity premia.

Larry Summers wrote a somewhat similar cautionary piece on 26 December titled Lack of fear gives cause for concern. Kenneth Rogoff discusses possibilities for the equity premium on Project Syndicate. And if you like to see these things on the sweep of history, look back at the First World War.

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