ESMA sets out views on financial market volatility
25 September 2018 Paris
Image: Shutterstock
“The potential of market volatility to undermine financial stability and impose unexpected losses on investors is a key element of its market monitoring”, according to The European Securities and Markets Authority (ESMA).
The association made the comments in a recent article, which sets out the details of its analysis of volatility in financial markets. This forms part of a 112-page report on trends, risks and vulnerabilities (TRV) issued earlier this month.
ESMA further stated relatively low or high levels of volatility increase the likelihood of stressed financial markets, as it found the two years between February 2016 and January 2018 were characterised by low yields and low volatility.
This trend came to an abrupt end in February 2018 when equity market volatility spiked as markets were globally affected by a strong correction.
ESMA said: “The main drivers of this extended period of low volatility are related to lower equity returns correlation, search-for-yield strategies, and stable macroeconomic and corporate performances.”
It added a prolonged period of low volatility could lead to a more fragile financial system.
The association also warned that promoting increased risk-taking by market participants driven by the use of value at risk models could also pose a threat to financial stability.
While the volume of assets under management may still be considered rather small, the number of products following volatility targeting strategies is sufficiently broad to become a key factor driving volatility spikes like those that occurred in the first week of February this year, the association added.
In its conclusion, ESMA stated: “Volatility is unavoidable and necessary to reflect the impact of changed market conditions on the process of pricing and transferring risk.”
It added: “Abrupt increases in volatility, as seen in February, may lead to unexpected severe losses for investors and raise financial stability concerns.”
The association made the comments in a recent article, which sets out the details of its analysis of volatility in financial markets. This forms part of a 112-page report on trends, risks and vulnerabilities (TRV) issued earlier this month.
ESMA further stated relatively low or high levels of volatility increase the likelihood of stressed financial markets, as it found the two years between February 2016 and January 2018 were characterised by low yields and low volatility.
This trend came to an abrupt end in February 2018 when equity market volatility spiked as markets were globally affected by a strong correction.
ESMA said: “The main drivers of this extended period of low volatility are related to lower equity returns correlation, search-for-yield strategies, and stable macroeconomic and corporate performances.”
It added a prolonged period of low volatility could lead to a more fragile financial system.
The association also warned that promoting increased risk-taking by market participants driven by the use of value at risk models could also pose a threat to financial stability.
While the volume of assets under management may still be considered rather small, the number of products following volatility targeting strategies is sufficiently broad to become a key factor driving volatility spikes like those that occurred in the first week of February this year, the association added.
In its conclusion, ESMA stated: “Volatility is unavoidable and necessary to reflect the impact of changed market conditions on the process of pricing and transferring risk.”
It added: “Abrupt increases in volatility, as seen in February, may lead to unexpected severe losses for investors and raise financial stability concerns.”
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