Risk Markets And Politics

Sunday, July 09, 2006

You heard it here first. Well, not really...

On July 11th of last year , I observed that:
As VIX [the US equity implied volatility index] makes new multi-year lows, David Merkel at RealMoney [$] notes: "many investors have become yield hogs, and have sold puts and calls to increase income in a tough environment. This is akin to the problems that bond managers face today in their quest to find yield." Meanwhile, Brad Setser is becoming more persistent in his suggestions that the U.S. housing market and, more generally, household wealth owes much to China's trade surplus and its impact on yields. Most intriguing is Tradesport's contract on whether the yuan will be revalued by January 1st; for it seems to be tracking the VIX since the beginning of the year.
Ten days later, China nominally discarded its currency's peg to the US dollar, revaluing by 2.1%. Lo and behold, the VIX has not been lower since the day before that surprise move (which also saw the lowest level since 1993):


Why Intrade's market seemed to track the VIX leading up to the announcement is open to debate, but the following crescendo reinforces the suspicion that it wasn't a meaningless coincidence. One interpretation is that someone was using the market as opposed to expressing a subjective probability of revaluation. It might be silly to suggest that someone was using the market to hedge against another position, and only $21,000 traded in the Dec05 contract (with $111,000 in all maturities), but this would be a straightforward explanation. In any case, this is one of the more interesting prediction markets to date.

(By the way, ten year yields bottomed in June 2005, over a month before the revaluation, and right about the time gold started gaining against all currencies.)

Thanks to Intrade for providing their data.

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