Talk of QE Withdrawal Impacts Wall Street

Stocks on Wall Street fell for the third consecutive day on Wednesday, driven by uncertainty and speculation on how US central banks will go about ending stimulus measures. Analysts think it likely that in the coming months the Federal Reserve will reduce its monthly bond purchases, thereby removing one of the pillars that has been supporting the rally stock markets have been enjoying this year. The Dow lost more than 200 points, as it has done seven times since Federal Reserve Chairman Ben Bernanke’s May 22 congressional testimony where he implied that the Fed may start to reduce its quantitative easing in coming months.

The CBOE Volatility Index – a Chicago Board Options Exchange Market Volatility Index also referred to as the ‘fear gauge’ or ‘fear index’ – has climbed more than 20 percent in the first three days of this week, confirming that the level of uncertainty the market is experiencing has increased quite dramatically. The concept of a volatility index was developed in 1986 by Professor Dan Galai and Professor Menachem Brenner and published in the July/August 1989 issue of Financial Analysts Journal under the title New Financial Instruments for Hedging Changes in Volatility. At the request of the CBOE, in 1992 this concept of an index to measure market volatility was developed by Professor Robert Whaley and became the VIX used by the CBOE today.

Quoted in percentage points, the VIX predicts movement in the Standard and Poor’s 500 index for the upcoming 30-day period, and this is annualized. The index has both proponents and critics, with the latter being quite outspoken at times. One such outspoken critic is Lebanese American scholar, Nassim Taleb who analyses issues related to probability, randomness and uncertainty. Taleb made his viewpoint on volatility known in a paper published in the Journal of Portfolio Management entitled We Don’t Quite Know What We are Talking About When We Talk About Volatility. Nevertheless, the VIX remains an index available to investors to assist them in their decision making process.