Analysis of the volatility index: the impact of news on disease outbreaks in equity and commodity markets
By Imlak Shaikh
The infectious disease epidemic has infected the global financial system in unprecedented ways; investors are forced to rebalance all investments and related derivatives (M&O) following current contagion developments. The COVID-19 epidemic has many consequences – it has had an impact on investment and savings, labor productivity and economic activity, as well as different approaches to risk management. Economic crises and the transmission of infectious diseases are closely linked; for example, a global financial crisis that occurred in 2008-09 encompassed H1N1, indicating a long-term impact of crises on the global health system.
To account for the future impact of COVID-19, it is essential to have a robust system for the database that can help with the forecast. Thus, healthcare institutions insist on digestible input data to make economic and financial forecasts. Media and analysts around the world have paid a lot of attention to the likely impact of COVID-19 on financial markets. It was found that the uncertainty induced by COVID-19 put great pressure on well-developed and emerging markets, not only for the stock market, but also for an uncontained impact on commodities; the current state of the market is calm, but wait and watch! The announcement of the global health emergency by the World Health Organization tipped the Dow Jones Industrial Average. He has appeared historically low with high fear and anxiety for the past 11 years.
The Chicago Board of Options Exchange’s Implied Volatility Index (VIX) has historically appeared at 82.69%, the highest level on March 16, 2020, while it was around 80% in 2008. Compared to the Afraid of emerging market investors, India Nifty VIX measured around 83.61%, Chinese VHSI 64.80% and Japanese VXJ 60.67%. This indicates that the Asian market exhibited extreme fear amid COVID-19 infection during the first quarter of 2020. Therefore, during the period of ambiguity, investors are not aware of the future consequences of the market. and continue to buy put options; therefore, the VIX level increases. During the initial period of the pandemic, investors flocked to hedge funds. On March 18, 2020, the put / call ratio of the SPX index options appeared to be 2.48 which is more than unity and implies excessive trading volume in the put options. Hence, this led to a higher premium on the put options resulting in higher implied volatility. The put / call ratio is the gauge of market sentiment; a higher ratio indicates greater fear in the market.
If we look at the market capitalization of the US stock market, about 10% are made up of energy companies. Therefore, investing in energy companies gives you better exposure to energy markets. The COVID-19 outbreak quickly disrupted the global supply chain and the economy; ultimately, it has led to a historic shift in the energy markets. Brent oil prices have warped by around 60% since the start of 2020, while US crude futures (WTI) have fallen by around 130% to levels well below -37 $ / b, and the Oil Volatility Index (OVX) peaked at 190.08%. The demand for energy and supply depends on the persistence of COVID-19; furthermore, locking, unlocking and social distancing, and new workplace standards. There have been monumental swings in global crude oil prices, and they have fallen 50-80% in the first quarter of 2020. For the first time in the history of oil futures, WTI and Brent in short-term curves have fallen an average of 20%, and oil and gas companies face increasing risk of insolvency. Also, if you consider the fear of investors in the forex market, considering the three major currencies against the US dollar. We observe that the dollar is feeling more nervous with a large amount of volatility against the Japanese yen (23.06%, JYVIX) and the British pound (24.34%, BPVIX).
We can therefore see that global trade experienced unprecedented volatility during the COVID-19 epidemic; still, the future consequences are unknown. Greater uncertainty, greater risk of market instability, unavailability of short selling could be one of the plausible reasons for increased uncertainty and volatility. Any market needs multiple lines of risk management, efficient price discovery, attractive liquidity. In our recent observation on world stock exchanges, we find that banning short selling leads to a higher probability of default, greater volatility of returns, steep declines in stock prices, and failure to meet policy goals. .
(Imlak Shaikh is Assistant Professor, Accounting and Finance at MDI Gurgaon)