High Volatility: A New Normal?
by Craig MacKinlay
As the first quarter closes, we have experienced a number of days where the movement of the stock market has been described as extreme by much of the financial press. Given this press, it is an appropriate time to ask if higher volatility is a new normal, and if so what are the implications for investing?
To tackle the first question, an important consideration is how to measure volatility. The news headlines often emphasize the magnitude of the movement in the Dow Jones Industrial Average. For example, a recent CNBC headline states “Dow drops more than 400 points as trade worries continue.” However, assessing the economic significance of a given decline in Dow Jones points can be tedious. The difficultly arises since the significance of the magnitude of the drop depends on the index level. For example, a drop in the Dow of 508 points on October 19, 1987 represented a large decline of 22.6%. In contrast, a drop of 742 points on March 22, 2018 represented only 2.9%. While this drop of 3 percent is still significant, it certainly pales in comparison to a 22% drop. To make comparisons more meaningful, it is best to work with the percentage change. This is the approach adopted for this note.