Daily Management Review

IMF warns of impending crisis, again


Another week, and another IMF’s warning about scenarios of financial collapse.

ramnath bhat via flickr
ramnath bhat via flickr
Last week, the IMF published a report on financial stability. In fact, the paper openly declaring that the financial system is on the verge of collapse.

The IMF uses the DSGE model to forecast the current global financial situation, and the fund's experts admit that concerns over continued debt build-up and overly stringent asset valuation may have global economic consequences. Simulating another "dislocation" collapse, the IMF conducts a "scenario analysis" to illustrate how a reassessment of risks can "lead to an increase in credit spreads and a fall in the capital market and property prices, undermining economic recovery and financial stability." 

This week, the IMF took another step by making sure that the main financial media published another warning aboutdangers of historically low volatility and related short-term volatility strategies.

According to the FT, the IMF warned that the increasing use of exotic financial products related to volatility of shares creates unknown risks that could lead to serious shock in the financial markets. In an interview with the Financial Times, the IMF's financial consultant Tobias Adrian said that the growing appetite for profitability is encouraging investors to look for ways to increase revenue through sophisticated tools.

"The combination of low returns and low volatility makes it easier for investors to use leverage to increase profits, and we are seeing rapid growth in some types of products that do it," he said.

This explains a number of short-term volatility strategies, which we have been discussing for several years.

Adrian's warning came amid growing evidence that pension funds and insurance companies were too immersed in investment risks to generate income.

Some of them also effectively sign insurance contracts against the collapse of the market. Last year, the $ 14 billion Hawaii retirement system signed a put option to increase its income, while other US pension systems, such as the South Carolina Pension System Commission and the Illinois Pension System, hired external managers to use options. According to the IMF, the assets invested in the strategy of targeting volatility have grown to about $ 500 billion, while this figure has increased more than half over the past three years. Marko Kolanovic, a derivative strategist at JPMorgan, last month warned about "strategies that are sold on "autopilot", and how risk management models that use volatility can lead investors to too high a risk.

"Very expensive assets often have very low volatility. Despite the risk of decline, they are considered to be absolutely safe," he said.

Despite the fact that it is impossible to ignore this warning from the IMF, it came too late. Moreover, the IMF seriously underestimates the scale of short-term risk in the financial markets.

According to Artemis, financial strategies for short-term volatility are either explicitly or implicitly more than $ 2 trillion. Nevertheless, both Artemis and the IMF are "on the same line" when it comes to what will happen when the volatility bursts steadily.

The IMF believes that sustained low volatility will force investors to assume higher levels of leverage, while at the same time will determine risk models that use volatility as an important contribution to underreporting real risk levels.

"A steady increase in volatility can then trigger a sell-off in the assets underlying these products, increasing the shock to the markets," Adrian said.

Given that stock volatility continues to fall during this year, those who bet that the markets will remain calm were rewarded. Nevertheless, it is hard to figure out the true number of sold complex products that are associated with the volatility of various assets, given that such transactions are mostly carried out privately. Therefore, it is difficult for regulators to identify risks in the event of an unexpected market shock.

source: ft.com