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2/18/2005
An Interesting Hypothesis...

appears in a recent Merrill Lynch report titled "The Economics of Volatility".

Their main point is that volatility is the price that investors demand for providing insurance, i.e. risk capital to the market. They go through some charting mysticism to predict that an increase in short term yields leads by 2 years an increase in volatility.

Since short-term interest rates rose one percent from June 2004, they predict a spike in volatility in the near future and recommend buying long term volatility now a la the expert, albeit his recommendation is for all times and if he's wrong he tends to put the blame on the demand schedules of his clients. But that's not the point.

 The authors state "when risk capital withdraws, riskier investments tend to be liquidated first. Emerging markets generally slot in that category quite well". Thus they predict that shortly Asian equities will fall and that volatility in Asian markets will rise.

Of course, this is untested. But like everything else it deserves to be tested.

I hypothesize that Asian equity markets lead US equity markets and that turning points in the former occur earlier than the latter. It's a good and useful thing to test and I might recommend the Henry George type of analysis that we used to test similar relations between real estate prices and equities in Practical Speculation as a related phenomenon and template.