Second Crash Warning From The IMF – This Time It's About Vol

Tyler Durden's picture

Another week, another warning regarding financial crash scenarios from those keen minds at the IMF.

In “Here Is The IMF’s Global Financial Crash Scenario” last week, we highlighted the institution’s surprisingly candid discussion hidden away in its latest Financial Stability Report “Rising Medium-Term Vulnerabilities Could Derail the Global Recovery"…or as we paraphrased the IMF’s “politically correct way of saying the financial system is on the verge of crashing”.

As we noted previously, in the section also called "Global Financial Dislocation Scenario" because "crash" sounds just a little too pedestrian, the IMF uses a DSGE model to project the current global financial situation, and ominously admits that "concerns about a continuing buildup in debt loads and overstretched asset valuations could have global economic repercussions" and - in modeling out the next crash, pardon "dislocation" - the IMF conducts a "scenario analysis" to illustrate how a repricing of risks could "lead to a rise in credit spreads and a fall in capital market and housing prices, derailing the economic recovery and undermining financial stability."

This week the IMF has gone a step further, courting the mainstream financial media to publicise its warning about the dangers of historically low volatility and related short volatility strategies.

As The FT reports, The International Monetary Fund has warned that the increasing use of exotic financial products tied to equity volatility by investors such as pension funds is creating unknown risks that could result in a severe shock to financial markets. In an interview with the Financial Times Tobias Adrian, director of the Monetary and Capital Markets Department of the IMF, said an increasing appetite for yield was driving investors to look for ways to boost income through complex instruments.

“The combination of low yields and low volatility facilitates the use of leverage by investors to increase returns, and we have seen rapid growth in some types of products that do this,” he said.

It explains some of the short vol strategies that we’ve been expressing concern about for several years. To wit.

Mr Adrian’s warning comes amid increasing evidence that pension funds and insurance companies are venturing into riskier types of investments to gain income.


Some are also effectively writing insurance contracts against a market crash to pocket premiums. Last year the $14bn Hawaii Employees Retirement System said it was writing put options to boost its income, while other US pension schemes such as the South Carolina Retirement System Investment Commission and Illinois State Universities Retirement System have also hired outside managers to use option writing strategies. The IMF estimates that assets invested in volatility targeting strategies have risen to about $500bn, with this amount increasing by more than half over the past three years. Marko Kolanovic, head of macro, derivative and quantitative Strategies at JPMorgan, last month warned of “strategies that sell on ‘autopilot’”, and how risk management models that use volatility could be luring investors into taking on too much risk.


“Very expensive assets often have very low volatility, and despite downside risk are deemed perfectly safe by these models,” he wrote in a note to clients.

While we applaud this warning from the IMF, it’s absurdly belated and the short vol “horse” has long since bolted. Moreover, we think that the IMF is seriously under-estimating the magnitude of short vol risk in financial markets. Indeed, the IMF’s research department would do well to read the recent report from Artemis Capital Management which we drew investors’ attention to.

Artemis estimates that financial engineering strategies that are short vol, either explicitly or implicitly, amount to more than $2 trillion. However, both Artemis and the IMF are “on the same page” when it comes to what would unfold if there was a sustained spike in volatility. The FT continues...

The IMF believes that sustained low volatility increases incentives for investors to take on higher levels of leverage while causing risk models that use volatility as an important input to understate real levels of risk participants may be taking on.

“A sustained increase in volatility could then trigger a sell-off in the assets underlying these products, amplifying the shock to markets,” Mr Adrian said…

With equity implied volatility continuing to drop over the course of this year, investors who have bet that markets will remain tranquil have been rewarded. Yet the true quantity of complex products being sold that are linked to volatility of various assets is hard to ascertain due to such deals mostly being done in private. Regulators therefore find it difficult to map out the risks in the event of an unexpected market shock.

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bh2's picture

Economists cannot accurately predict the future. Wow! Who knew?

Five Star's picture

Commercial and industrial credit growth has never been this low withouta recession

besnook's picture

housing hasn't recovered to levels in 2007 even though 15mil households have formed since then. new home building is barely at the level that previously used to signal the start of a recession.

SoDamnMad's picture

15 MIL households formed living with mom and dad, rentals, trailers, sharing of apartments, back rooms of office or business space. Can't afford the down payments of large monthly mortgage payment of decent houses.

Secret Weapon's picture

The down payment is being eaten up by insurance premiums.

besnook's picture

the pension funds must be listening to that dude in florida trading vix put options in between picking his kids up at school and making breakfast for his gainfully employed wife who wanted to start a hedge fund using his laptop to trade from home while jerking off to pornhub.

fattail's picture

That's actually a very enticing business model.  Send the wife to work and then "work from home" clicking on a mouse.  Kudos to the florida dude.  I might try to copy it.

Batman11's picture

The IMF are Mickey Mouse.

Mickey Mouse economics for the New World Order of the Washington Consensus.

If we obeyed the laws of a new scientific economics it would bring prosperity to all.

A technocrat elite would ensure everything ran well.

It didn’t happen did it?

The Mickey Mouse economists always think austerity is the answer.

The IMF predicted Greek GDP would have recovered by 2015 with austerity.

By 2015 it was down 27% and still falling.

Richard Koo had to explain to the IMF how they had pushed Greece into debt deflation. 

The evidence is now in from the Euro-zone, the harsher the austerity the more damage was done to the economy.

What do the Mickey Mouse IMF economists know?

Batman11's picture

Blowing up the world with Mickey Mouse economics.

Japan would have seen what was coming if they had looked at unproductive lending in the economy.

They didn’t and it blew up in 1989. 

“2008 – How did that happen?” the Mickey Mouse economists.

It was obvious, if you looked at unproductive lending building in the economy:

The Mickey Mouse economists in the UK haven’t even realised the UK’s financial speculation and real estate economy is totally unsustainable.

China would have seen the Minsky Moment developing if they had looked at unproductive lending in the economy.

They didn’t.

Canada, Australia, Norway and Sweden are being run with Mickey Mouse economics, no one with any sense would let real estate bubbles like those develop.


How can we stop unproductive lending building up in the economy?

It’s easy.

Richard Werner was in Japan in 1989 and worked it out.



Batman11's picture

Those that saw 2008 coming said you can’t solve a debt problem with more debt.

Mickey Mouse thought you could.

Mickey couldn't even work out the problem, because he doesn't look at private debt.

East Indian's picture

Everything on track and going smooth towards restoring the feudal society once again. Dont disturb by pointing out irrelevant indices now. 



indygo55's picture

I can't wait till the knights on horseback come back. Those Monty Python clips will be the new "news".


wisebastard's picture

BS.....all yall have to do to keep kicking the can down the road is have congress promise not to audit the FED or investigate the military industrial comlex.....BAM we can then call it the $&P500,000

Herodotus's picture

The German stock market also went up 500,000%, but investors in stocks ended up losing half of their purchasing power because inflation went up 1,000,000%.

Dragon HAwk's picture

Who Buys the ETF's on the Way Down?

MansaMusa's picture

Belgium will buy them....

Let it Go's picture

Not long ago former chief economist of the Bank for International Settlements, William White, told Bloomberg TV that "the system is dangerously unanchored." White voiced his concerns such as prices being very high, in particular for high-yield assets and equities, VIX at very low levels, and house prices are rising strongly.

What stood out in my mind was his indication that central banks cannot or will not be able to solve what might be seen as a growing "liquidity problem." White pointed out that Europe's creditors are likely to face some of the biggest haircuts. This is a bit ironic coming at a time the euro is surging ever higher. more on this subject in the article below'

 http://Former BIS Chief Warns System Dangerously Unanchored.html

buzzsaw99's picture

who do, who do you think you're foolin'?  [/the devil]

buzzsaw99's picture

my mama yellen loves me like a rock,

she loves me like the hobbit rock of ages...

[/goldman boyz refrain]

Herdee's picture

The Central Banks will just keep printing and hold everything up, straight into hyperinflation. Some see a deflationary cycle coming, I say that they haven't printed all this fiat currency worldwide in order to see their plans all go up in smoke. These are all dedicated printers on behalf of government deficits and uncontrolled spending. It's print or bust time on an exponential scale. That's why Trump wants trillion dollar deficits, it's called "stimulation". Actually it should be called the shit dollar experiment. They've desperate to do what China has done, they need bridges, roads and ghost cities to nowhere in order to hold up the money illusion dream.