How To Predict Volatility In Eurozone

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1 April 5 Volatility and Correlation for Key Risk Drivers in Europe About This Report Highlights Under a standard RiskMetrics forecasting model, this monthly Risk Monitor reports on the evolution of risk forecasts for key risk factors chosen for their relevance to European investments. The factors are selected each month, depending on market developments, from the list on page. The report examines changes in volatility and correlation behavior, and identifies days on which factor returns were a surprise relative to the risk forecasts. This Risk Monitor may be used to assess risk forecasts of the key factors specifically, or to provide context for the performance of risk forecasts on more general portfolios. Forecast volatility over the past year page Short- versus long-term correlations page 3 Summary of surprise days page Individual risk factor detail pages 5- Risk factor descriptions page In March 5, we observed 5 return exceedances for the risk factors monitored in this report. Three foreign exchange risk factors (EUR/USD, GBP/USD and NOK/EUR) and two interest rate risk factors (EUR Swap 5Y and EUR Govt Y) reached peak volatility during the past months. At the same time, yields declined and EUR weakened against USD (see pages and ). The European Central Bank (ECB) began its bond-buying program on March 9 ( 5bn/week), pushing European short-term yields deeper into negative territory, further weakening the Euro and lowering the yield for longer-dated bonds. We observed negative return exceedances for the UK Y, EUR Y and EUR Y interest rates, for the EUR 5Y Swap rate, and for the EUR relative to GBP and USD (see pages 5, 7 and 9). On March 8, the U.S. Federal Reserve expressed caution about economic growth, suggesting a less aggressive timeline for an interest rate hike. This allowed the Euro to recover partially, and a positive return exceedance for EUR/USD was observed on March (see page 7). On March 9, the Norwegian Central Bank announced maintaining its interest rates at current levels instead of cutting them as expected. On the same day, the Norwegian Krone appreciated by more than 3 percent relative to the Euro, and the NOK/EUR return exceeded the -sigma volatility forecast (see page ).

2 Forecast Volatility Volatility Stats for EWMA (decay factor of.97) April 5. Risk Forecast of Daily Absolute Changes in Rates (BPS) over Prior Month, Prior Three Months, and Prior Year (decay =.97) Volatility stats for EWMA.97 Prior Month Prior Three Months Prior Year Return Avg. Vol. Min. Vol. Max. Vol. Return Avg. Vol. Min. Vol. Max. Vol. Return Avg. Vol. Min. Vol. Max. Vol. UK Govt Y EUR Swap 5Y EUR Govt Y EUR Govt Y Prior Month Date Range: March, 5 March 3, 5. Three-Month Date Range: January, 5 March 3, 5. One-Year Date Range: April, March 3, 5.. Risk Forecast of Daily Relative (Log) Changes over Prior Month, Prior Three Months, and Prior Year (decay =.97) One-Year Date Range: April, March 3, 5. Prior Month Prior Three Months Prior Year Return Avg. Vol. Min. Vol. Max. Vol. Return Avg. Vol. Min. Vol. Max. Vol. Return Avg. Vol. Min. Vol. Max. Vol. itraxx Europe OTR.67%.75%.6%.9% -.66%.95%.6% 3.% -6.8%.7%.99% 3.75% itraxx Europe XOVER.6%.58%.3%.7% -.%.8%.3% 3.3% -6.8%.78%.%.6% EUR/USD -.5%.66%.56%.7% -.%.6%.8%.7% -.8%.%.3%.7% GBP/EUR.3%.5%.8%.5% 7.7%.5%.%.56%.7%.38%.7%.56% Eurostoxx.73%.%.9%.8% 7.5%.3%.9%.6% 6.95%.7%.68%.6% V Stoxx 3.7% 6.58% 6.% 6.93% -3.7% 7.3% 6.% 8.56%.5% 6.95% 5.7% 8.85% GBP/USD -3.9%.8%.%.5% -.79%.%.35%.5% -.96%.35%.3%.5% NOK/EUR -.%.8%.7%.9%.8%.77%.67%.9% -.67%.5%.9%.9% Prior Month Date Range: March, 5 March 3, 5. Three-Month Date Range: January, 5 March 3, 5. One-Year Date Range: April, March 3, 5. Highlighted prior month volatilities indicate that the volatility level reached its minimum/maximum value of the last three months or twelve months. The relevant threemonth/ twelve-month minimum/maximum values are highlighted as well. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page

3 Correlation Changes Long-term versus Short-term Correlation Structure April 5 Top Right Matrix: Correlation of daily returns of the past three years. Bottom Left Matrix: Correlation of daily returns of the past three months. UK Govt EUR Swap Itraxx Itraxx EUR/USD GBP/EUR Eurostoxx V Stoxx EUR Govt EUR Govt GBP/USD NOK/EUR Y 5Y Main Crossover Y Y UK Govt Y % 8% -% -5% % 6% 7% -3% 5% 57% 7% -3% EUR Swap 5Y 6% % -33% -3% 3% -% 3% -5% 5% 8% 5% % itraxx Europe OTR -8% -8% % 95% -5% 5% -78% 68% -% -35% -3% -9% itraxx Europe XOVER -6% -3% 96% % -3% % -77% 67% -9% -33% -% -% EUR/USD -% 9% % % % -6% 5% -8% 5% % 57% -6% GBP/EUR 6% -8% -5% -% -69% % -% -3% -% -5% 3% % Eurostoxx % % -73% -76% -5% 3% % -75% % % 7% 7% V Stoxx -7% -9% 7% 68% 7% -% -78% % -6% -7% -3% -6% EUR Govt Y % 3% 3% % 6% -7% % -5% % 7% 9% -% EUR Govt Y 6% 83% -5% -6% 5% -3% 3% -% 37% % 8% -5% GBP/USD 5% % -% -8% 6% % % -6% -7% % % 3% NOK/EUR 5% % -7% -% -6% 5% % -5% 7% 7% -8% % Three-Month Date Range: January, 5 March 3, 5. Three-Year Date Range: April, March 3, 5. * Cells are highlighted according to the difference between the short-term (three-month) and long- term (three-year) correlation, normalized by the standard deviation of the short-term correlation. Light green (red) highlighted cells indicate a recent correlation in excess of one standard deviation higher (lower) than the long-term value. Dark green (red) highlighted cells indicate a recent correlation in excess of two standard deviations higher (lower) than the longterm value. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page 3

4 Surprise count Risk Factor Surprise Days April 5 9 /5 8 / 7 6 / 5 /3 3 /6 / /5 3/6 3/ UK Govt Y EUR Swap 5Y Itraxx Main Itraxx Cros s over EUR/USD GBP/EUR Euros toxx V Stoxx EUR Govt Y EUR Govt Y GBP/USD NOK/EUR / / /8 /8 /8 /8 /7 3/ 3/3 Date Range: October, March 3, 5. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page

5 Basis points Basis points Risk Factor Plots April 5. UK Two-year Government Bond. EUR 5-year Swap UK Two-year Government Bond: Exceedances EUR 5-year Swap: 5 Exceedances 8 6 /6 3/6 5 / 3/ /3 3/ -6 3/8-5 /6-8 3/ - / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page 5

6 Percent Percent Risk Factor Plots April 5. itraxx Europe OTR. itraxx Europe XOVER OTR itraxx Europe OTR: Exceedance itraxx Europe XOVER OTR: Exceedances / /8-6 3/ / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page 6

7 Percent Percent Risk Factor Plots April 5. EUR/USD. GBP/EUR EUR/USD: 8 Exceedances GBP/EUR: 7 Exceedances.5 /9 3/.5 /5 / 3/ /3 /8 3/ /5 / /3 /6 3/6 3/ /3 / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page 7

8 Percent Percent Risk Factor Plots April 5. Euro Stoxx 5 Index. VSTOXX Euro Stoxx 5 Index: 3 Exceedances VSTOXX: Exceedance /8 /9 3 3/ /5 - / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page 8

9 Basis points Basis points Risk Factor Plots April 5. EUR Two-year Government Bond. EUR -year Government Bond EUR Two-year Government Bond: 5 Exceedances EUR -year Government Bond: 6 Exceedances 3 3/6 8 6 / /5 3/ 3/8 3/ /6 / /3 3/9 3/ - - / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page 9

10 Percent Percent Risk Factor Plots April 5. GBP/USD. NOK/EUR GBP/USD: 7 Exceedances NOK/EUR: Exceedances.5 /7 3/ 3 3/9.5 /8 /5 3/ /5 / 3/6 3/ 3/ / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. / / / /3 / /9 3/ 3/ 3/ 3/3 Date Range: January, 5 March 3, 5. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page

11 Appendix Risk Factor Definitions April 5 CHF/EUR: CHF/EUR Foreign Exchange Rate derived from CHF/USD and EUR/USD mid quotes snapped at EST. EUR -year Government Bond: Euro Government -Year Zero Rate, constructed by MSCI from on-the-run German Bunds. EUR Two-year Government Bond: Euro Government Two-Year Zero Rate, constructed by MSCI from on-the-run German Bunds. EUR Three-month LIBOR: Three-month EUR Swap Zero Rate, constructed by MSCI from deposit rates. EUR 5-year Swap: 5-year Euro Swap Zero Rate constructed by MSCI from broker swap quotes. Appears in the report each month. EUR/USD: Mid quote for EUR/USD Foreign Exchange Rate snapped at EST. Appears in the report each month. Euribor Three-month Volatility: Implied volatility of three months at-themoney options on Euribor interest rate futures. Euro Stoxx 5 Index: The Euro Stoxx 5 equity index using end-of-day closing prices. Appears in the report each month. GBP/EUR: GBP/EUR Foreign Exchange Rate derived from GBP/USD and EUR/USD mid quotes snapped at EST. Appears in the report each month. GBP/USD: Mid quote for GBP/USD Foreign Exchange Rate snapped at EST. itraxx Europe OTR: Five-year itraxx Europe index spread level, constructed by MSCI using the most liquid five-year itraxx Europe Index and smoothed over a period when a new series becomes on-the-run. Appears in the report each month. itraxx Europe Senior Financials OTR: Five-year itraxx Europe Senior Financials index spread level, constructed by MSCI using the most liquid fiveyear itraxx Europe Senior Financials Index and smoothed over a period when a new series becomes on-the-run. itraxx Europe XOVER OTR: Five-year itraxx Europe Crossover index spread level, constructed by MSCI using the most liquid five-year itraxx Europe Crossover Index and smoothed over a period when a new series becomes on-the-run. Appears in the report each month. itraxx LevX S6: Five-year itraxx Senior LevX Series 6 derived index spread level. Series 8 began trading on March, and contains constituents. itraxx SOVX WE OTR: Five-year SovX Western Europe spread level, constructed by MSCI using the most liquid five-year itraxx SovX Western Europe Index and smoothed over a period when a new series becomes onthe-run. JPY/EUR: JPY/EUR Foreign Exchange Rate derived from EUR/USD and USD/JPY mid quotes snapped at EST. MSCI EM Europe Index in EUR: The MSCI Emerging Market Europe equity index using end-of-day closing prices quoted in Euros. MSCI Europe Index in EUR: The MSCI Europe equity index using end-of-day closing prices quoted in Euros. NOK/EUR: NOK/EUR Foreign Exchange Rate derived from EUR/USD and USD/NOK mid quotes snapped at EST. Short Sterling Three-month Volatility: Implied volatility of three months atthe-money options on Short Sterling interest rate futures. UK -year Government Bond: UK Government -Year Zero Rate, constructed by MSCI from on-the-run UK Gilts. UK Two-year Government Bond: UK Government Two-Year Zero Rate, constructed by MSCI from on-the-run UK Gilts. Appears in the report each month. UK Three-month LIBOR: Three-month GBP Swap rate quote from BBA. VSTOXX: The Euro Stoxx 5 Volatility Index using end-of-day closing prices. Appears in the report each month. 5 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document Page

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