While Janet Yellen is bust ignoring “noisy” inflation and dismissing low volatility as indicative of any complacency, Goldman is a little more concerned. The decline in economic and asset market volatility this year from already low levels in 2013 has been striking, which as Markus Brunnermeier states, means “the whole system is more prone to a financial crisis when measured volatility is low, which tends to lead to a build-up of risk in the background – the so-called ‘volatility paradox’.”
“In general, extremely low risk premiums right now are somewhat concerning… If there is a smooth adjustment towards more normal levels of risk premium, I believe the financial system can handle it. But if risk premiums suddenly move back to high levels… the question is how the financial system will react.”
Allison Nathan: Does low market volatility breed complacency and excessive risk taking?
Markus Brunnermeier: Yes. I have coined this dynamic the “volatility paradox.” When measured market volatility is low, people feel empowered to take on more leverage and more liquidity mismatch, which leaves the whole system more prone to sharp movements. This dynamic occurred during the “Great Moderation.” During that period, fundamental and asset volatility was generally low and market participants took on much more leverage.
Source: Goldman Sachs
via Zero Hedge http://ift.tt/1m2Lm8t Tyler Durden