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Regional Variations in Volatility to Japan’s Black Monday

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Regional Variations in Volatility to Japan’s Black Monday

 

Dinank Chitkara
August 27, 2024

On Aug. 5, global equity markets declined, with Japan leading the drop at 10%.1 The declines were accompanied by a major surge in volatility, inverted term structure and heightened implied-volatility skew.

How we got here

Volatility intensified within already-jittery global equity markets, after the Bank of Japan’s (BOJ) unexpected 0.25% rate hike on July 31, ending its longstanding zero-rate policy. The subsequent JPY appreciation triggered the unwinding of carry trades due to the less favorable differential in U.S. and Japanese interest rates.

A rise in the U.S. unemployment rate to 4.3% fueled fears of a hard landing, spurring record-setting single-day trading volume of over 70 million options contracts in the U.S. equity and index options markets on Aug. 2.

Emerging markets’ notably low-key response

On the following Monday, the emerging markets (EM) and EAFE had smaller increases in volatility and other volatility-based metrics compared to the U.S. The spread between the EM (VXMXEF) and U.S. volatility (Cboe® VIX®) indexes contracted by 8.9%, against an average spread of 0.5% over the five years ending Aug. 23, 2024. In contrast, the spread between the EAFE volatility (VXMXEA) and VIX indexes rose to 11.9%, compared to an average spread of 2.5% over the last five years.

Given that markets had been pricing a soft-landing scenario, these divergent reactions could be due to investors’ reassessing expected market returns across different regions. Another explanation could be EM’s lower economic exposure2 to the U.S .and Japan, the economies facing the largest potential macroeconomic changes.

Although market volatility has declined sharply following the BOJ’s ruling out further rate hikes amid ongoing market instability, should the BOJ resume rate hikes and volatility reassert itself, investors may glean useful insights from the recently observed differences between regional markets.

Record-low spread between MSCI EM Volatility Index (VXMXEF) and VIX

 
Data period from Aug. 1, 2019, to Aug 23, 2024. EM equity market volatility represented by the MSCI EM Volatility Index (VXMXEF). EAFE equity market volatility represented by the MSCI EAFE Volatility Index (VXMXEA). U.S. equity market volatility represented by the VIX Index. Source: Cboe

Rise in volatility-based metrics implied heightened short-term risks

 
Data period from Aug. 1, 2019, to Aug. 23, 2024. The implied-volatility skew is calculated using the five-day moving average of the put-call implied-volatility spread of 91-day 20-delta strikes. The “put option as a percentage of the spot price” shows the premium of a three-month 95% put option. Term structure is calculated using the 91-day to 365-day implied-volatility ratio of at-the-money options, Options linked to the MSCI EAFE, MSCI Emerging Markets and S&P 500 Indexes were used to calculate the implied-volatility skew and other metrics for the EAFE, EM and U.S. regions, respectively. Source: OptionMetrics


1 Stated in gross USD.

2 MSCI Economic Exposure data helps estimate the portion of a company's global revenues originating from individual markets and regions worldwide.

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