Systemic Liquidity Risk and Bipolar Markets: Wealth Management in Today's Macro Risk On/Risk Off Financial Environment

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Adjusting to More Correlated Financial Markets

The previous chapter contained some provocative views as to the nature of the emotional and cognitive kinds of dissonance which manifest themselves in the day to day gyrations of modern markets. The bipolarity of the risk on/risk off paradigm can be seen at the surface level as the outcome of several empirically observable developments in the financial world following the global financial crisis. Undoubtedly the directly observable changes in market behavior are a large part of the explanation for the increased correlations, greater outlier risks, and the binary risk on/risk off paradigm. Much of the evidence presented in this book – the detailed and forensic analysis of price developments and the review of changes in market microstructure – have focused on these direct observables.

A quick summary of the most pertinent observables in financial markets would have to include the following: lack of institutional participation as reflected in the decline in the volume of real trading on exchanges as contrasted with the now almost ubiquitous presence of algorithmic “churn”; the fact that monetary policy has been “unorthodox” for several years; the anxieties regarding a potential breakup of the Eurozone; the growing importance of China in a globalized economy; and the prevalence of highly coordinated and correlation based trading strategies in many markets have all been featured prominently in the discussion.

The more conjectural underpinnings ...