Saturday, August 25, 2007

VIX suggests that the market crisis is over

The CBOE Implied Market Volatility Index (VIX) strongly suggests that the recent financial "crisis" is over.

The VIX "fear gauge" stayed under 20 in the pre-crisis period through July 25, 2007.

It spiked above 20 (intra-day peak of 23.36) and closed at 20.74 on July 26, 2007, marking the beginning of the market "crisis".

It bounced around in a range, no higher than 26.40 (early crisis) until August 9, 2007 when it hit an intra-day peak of 26.90 and closed at 26.48. This marked the beginning of the "crisis" itself.

The actual peak of the crisis was on Thursday, August 16, 2007 when VIX spiked as high as 37.50 intraday and closed at 30.83. In addition to being the peak, the decline marked the end of the "crisis."

The Fed cut the discount rate the next day (Friday, August 17, 2007), but VIX did not show the "crisis" as clearly subsiding until the following Monday when VIX closed at 26.33 after opening up at 29.87.

VIX fell moderately on each of the following four trading days, closing Friday, August 24, 2007 at 20.72.

Technically, people are still worried that the "crisis" will surge back, but given the steep fall-off over seven trading days and the itchy trigger finger of the Fed, VIX strongly suggests that the "crisis" is behind us.

Sure, I'd like to see VIX below 20 for a couple of weeks to completely confirm the end of the "crisis", but that is all a matter of people seeing some follow-through on the financial markets.

I call the current "crisis" a mini-crisis because it it so much less severe than what we saw back in 1998. On October 8, 1998, VIX spiked up to 49.53, but we didn't even get close to 40 this time. You could argue that the Fed nipped the crisis in the bud better this time, but no matter how you slice it, we simply have not seen the levels of raw "fear" that were associated with past market crises. So, I have to chalk this one up as being a mere "mini-crisis."

But whatever you want to call it, it is now most likely behind us.

Note: The current VIX ("new VIX") is different that the old VIX that was in use back in 1998 and during other crises. It is believed that the hostorical data has been properly adjusted to reflect new VIX, but I am at least somewhat skeptical. Old VIX was based on S&P 100 index futures, but in September 2003 it was changed to be based on S&P 500 index futures. The overall concept is still the same, but trying to judge the level of a crisis or panic using a different index may not be a 100% reliable approach. The bottom line is that we will need to see two or three full-blown crises, not a mini-crisis such as this one, before we can better calibrate new VIX for the new financial markets.

I have a web page with some information on VIX.

-- Jack Krupansky

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