Xin Chen (et al.) from the Shenzhen Audencia Financial Technology Institute at the Shenzhen University address an issue that’s especially pertinent right now. Why, in times of elevated economic uncertainty, are markets often so often ‘quiet’?
In academic terms the question repeats as ‘Why, in times of high economic policy uncertainty (EPU), is volatility low and mispricing of stocks weaker than at times of low EPU?’
In the literature, classically, high EPU deters investment, retards decision making and that has knock on effects in subsequent periods. The paper doesn’t dwell on that analysis but instead asks why markets confronted with high EPU aren’t wilder rides than they have been?
The paper is short and the conclusion intuitive and if you need the deeper dive you’ll find the work in full via the following link Economic uncertainty and stock mispricing in China.
For those with less time here’s the summary: in times of high EPU market participants express a range of views they’re not inclined to when things are more settled. Longs meet shorts in greater numbers at these times, optimists and pessimists confront each other as they don’t when more consensual markets are in operation and this confrontation of positions ends up smoothing out short term volatility and mis-pricing. Stability it turns out is comes from a wide range of views being expressed.
The time to be wary is when too many agree on the same thing and are positioned the same way, which also makes intuitive sense to any of us who’ve invested for a while.
Happy Sunday.