![\"investors-are-not-complacent-in-assessing-risks.png\"](\"http:\/\/www.next-finance.net\/http:\/\/beta.next-finance.net\/wp-content\/uploads\/2017\/11\/investors-are-not-complacent-in-assessing-risks.png\")
<\/a><\/p>\nRisk prediction models<\/strong><\/p>\n To predict likely future risk, investors can use the Autoregressive Conditional Heteroscedasticity (ARCH) model, where risk is assessed by looking at previous (autoregressive) deviations from the norm. \u201cOf course, the past is not the only factor, since volatility will also change due to information that has become recently available,\u201d says Hoek, a portfolio strategist with Robeco Investment Solutions.<\/p>\n \u201cIf we use the model to capture today\u2019s market, it shows that volatility has remained in line with the previous low readings, and that there has been no new information that was sufficiently serious enough to derail it. Brexit and Trump only led to temporary shocks that soon faded out, and markets quickly reverted to their underlying trend.\u201d<\/p>\n \u201cOther models found that \u2018in general, historical volatility computed over many past periods provides the most accurate forecasts\u2019. So we don\u2019t need a complex model to make predictions, especially for longer periods like the coming five years: a mod-el using historical volatilities over different periods will be sufficient.\u201d<\/p>\n History on their side<\/strong><\/p>\n How then to make predictions such as those contained in Expected Returns 2018-2022? \u201cLooking at all the historical lessons, it would be most logical for the market to be expecting higher or more normal volatility than today\u2019s low level, even over a shorter time period than five years,\u201d says Hoek.<\/p>\n \u201cSo those commentators who predict a return of volatility have history on their side. But why then is the market so complacent? To answer this question, we must turn to the exceptional role central banks have played since the 2008 financial crisis.\u201d<\/p>\n He says massive quantitative easing programs and historically low (and even negative) interest rates mean central banks have effectively put a floor under volatility. \u201cIt is no surprise then that markets expect risk to remain low as long as central banks retain this stance,\u201d he says. \u201cWith this in mind, it seems as though the market has been more on the ball than those commentators who predicted a return of risk.\u201d<\/p>\n SKEWing the figures<\/strong><\/p>\n However, the picture changes if we look at another measure of risk, he says. Market traders use models such as Black-Scholes to assess volatility risk when pricing options. Here, the market often assigns higher probability to tail risks, which can be measured by the SKEW Index. If the SKEW increases, it generally means that more investors feel there is a greater risk that a disaster will occur.<\/p>\n \u201cOver the last seven years, the market has had a higher level of SKEW than it did in the 1990s,\u201d says Hoek. \u201cThis is in stark contrast to the downward trend in the VIX level over the same period. Even more surprising is the level of the SKEW in 2017, which is well above the average.\u201d<\/p>\n Overall, it implies that central bank action has proved to be a powerful tool in reducing volatility, but the market does not believe that central banks can halt the next crisis. \u201cIn short, the market, commentators and regulators all agree that we would be wise to keep an eye on the tail risks,\u201d Hoek concludes.
\n