Volatility: Why High Moves Fast, Low Moves Slow

Key Concepts

• Mean Reversion: The tendency of a metric, like volatility, to return to its historical average over time.
• Volatility Expansion: A period where volatility significantly increases.
• Volatility Contraction: A period where volatility significantly decreases.
• Asymmetric Nature of Volatility: The observation that volatility's return to its mean is not symmetrical; it tends to revert faster from high levels than from low levels.
• Inverse Relationship between Market Prices and Volatility: As market prices generally trend upwards, volatility tends to trend downwards, and vice versa.

Volatility as a Mean-Reverting Metric

The transcript highlights that volatility has been empirically demonstrated to be a mean-reverting metric. This means that when volatility expands (i.e., increases significantly), it has a tendency to subsequently decrease. Conversely, when volatility contracts (i.e., decreases significantly), it tends to increase over time, moving back towards its historical average.

Asymmetric Behavior of Volatility

A crucial point emphasized is that the mean reversion of volatility is not symmetric. The transcript states that "those two sides to the coin are not necessarily symmetric." Specifically:

• After Expansion: When volatility has expanded significantly, it "does not like to live on the higher end of the range." Consequently, after a substantial expansion, volatility typically begins to move lower and contract back towards its historical average, often not taking a long time to do so.
• After Contraction: When volatility is naturally moving lower and contracting, it "can stay low or move lower for a very long time." This indicates a slower and more prolonged descent from high levels compared to the ascent from low levels.

Inverse Relationship Between Market Prices and Volatility

The transcript explains the underlying reason for this asymmetric behavior by referencing the "naturally inverse relationship" between market volatility and market prices. The argument presented is:

• As market prices are "slowly grinding higher over time," it is logical that volatility would "follow suit and slowly grinding lower." This gradual upward trend in prices is associated with a gradual downward trend in volatility.

Conclusion

The main takeaway is that volatility is a mean-reverting phenomenon with an asymmetric characteristic. While it tends to return to its average from both high and low points, its reversion from high levels is typically faster than its reversion from low levels. This behavior is intrinsically linked to the inverse relationship between market prices and volatility, where rising markets are generally accompanied by falling volatility, and this process can be prolonged when volatility is already low.