Financial markets have been strongly nervous for a last few months. You can read in newspapers almost every day articles about black Monday, Tuesday or whatever other day :-). The next day is, at the opposite, marked as good one, with markets sailing on optimistic mood (and therefore the indexes’ changes figures are green-coloured 🙂 ). And right another day is again the disastrous one, with markets sinking down again.
In this article I want to show you, in a really simple way, that this period of increased instability of markets in not so exceptional, from the historical point of view.
Let’s see the first chart:
Here is shown the development of NYSE Composite daily index of Closing Price, ranging from 1966 to 26. March 2008. The trend is up warding, in general, but clearly, you can see the large drop after pricking of the dot com bubble. After that, the markets recovered somewhere around 2003 and experienced strong and steady growth, which lasted till the sub-prime mortgage crisis. However, this chart will not tell us much about instability of markets – much better view offers the next chart:
These returns were computed simply by taking logs of the closing prices’ time-series shown above and after that, we subtracted from one observation the previous one. The result is shown here:
We can see the so-called “volatility clustering” phenomenon. That is nothing more, that the period of high volatility is followed again by period of high volatility and vice-versa. We can clearly see, that during examined period, there were quite frequent periods with high and low volatility. If we focus on the period ranging from the end of nineties to today, we may see that before and after the burst of dot com bubble, markets were unstable. From year 2002 they stabilized themselves and now the volatility is rising again. We may only guess, that this periods of instability were caused namely by speculative purchases and sales of securities.
The volatility may be seen in this chart, which displays it in a very nice way. For those, who knows what is this about – it was computed as GARCH(1,1).
The periods of high volatility, i.e. the instability of financial markets can be clearly seen.
But the most important thing stemming from this chart is, that were a lot of periods of instability and all of them ended after some time.
Thus, current situation is nothing exceptional, from this point of view and we may expect the recovery, sooner or later. The periods of higher volatility may be seen as periods of market corrections, getting rid of the overvalued assets.
Czech version of this article can be found here: