When I was a prop trader at Lehman in the early '90s, markets were very volatile then.
And we managed our risk in the way that people managed risk forever, which is essentially
you'd look at your positions, and you'd say, how much would I lose if I were stopped out.
And your boss would ask you, and your boss would tally all of that risk up, and you'd
have a general sense for how much risk you took as a firm.
In 1994, '95, we were introduced to this thing called VaR, Value at Risk, which was new.
Everyone today thinks that that's just the way risk is measured and has always been measured,
and it's just not.
But we took a look at it, try to understand what it was, because management wanted us
to look at our positions through this VaR lens.
And we thought it was just foolish, which it was.
But we also recognized that if you were trying to assess the overall level of risk for a
really large, complex portfolio, it was deeply flawed, but it was probably better than almost
anything else that you had.
Because it's just unrealistic to look at your stop-losses across the whole firm like that
and tally them up.
Fast forward a couple decades at this point.
Every portfolio in the world looks at risk exactly the same way.
They look at risks through the lens of VaR.
Large pension plans, they may just look at the overall vol of their portfolio.
But in essence, everyone in the world is using the same measurement of risk.
And what's incredibly interesting is that not only are they using it to measure their
risk, but they're using it to kind of calibrate their whole portfolio so that as they observe
this thing called VaR or vol for their portfolio, and as it moves lower-- and central banks
have intended to push it lower-- it allows them to take more risk without their portfolio
looking like it's any riskier.
In fact, if they do nothing with their portfolio and vol comes down, it looks like they're
not taking that much risk.
In fact, they may be taking just as much, potentially even more.
And so what's happened is all these portfolios globally have been taking on more and more
risk as the central bank policy has suppressed vol.
And it becomes a reflexive process, because the more risk they take, what are they doing?
They're putting their money into risky assets.
And as they buy those assets, inevitably the volatility of those assets comes down.
It ends up showing a lower vol, or a lower VaR number.
And so, in a sense, the more risk they've taken, the more they've suppressed risk themselves
and suppressed vol.
So it's a reflexive process.
And you don't see that many of those in your career.
I've seen a few of them.
This is clearly one of them.
And so that type of reflexivity, meaning lower vol begetting lower vol, will work in reverse
when vol begins to move higher.
I think right now, vol is-- I think we got a glimpse of it in February, where you had
some really illconstructed Vicks products in the volatility ETF space that blew up dramatically.
That was a reflexive process in a very compressed time horizon.
But that was a reflexive process where higher vol begot higher vol in these indices, and
the ETFs ended up going to zero, effectively, in a matter of a day.
But I think on a much more widespread basis, that's what we will see as we proceed into
this next bear market, into this next recession.
Certainly into this next bear market, where you'll see higher vol levels across asset
classes.
And these are all things that people are very short, both explicitly and implicitly shortfall,
across every asset class.