January 10th, 2003, 7:45 pm
<i>When an economist says that there is "too much" volatility he means that markets are more volatile than his theories suggest. The economist wants to improve his theory of volatility. I don't understand why that should be any more silly than trying to have a theory of what price something should be.</i> The "silly" part, to me, is a theory that leads to a conclusion that observed levels of market volatility are grossly too high or"irrational". The reason I say this is that what little I know of rational equilibrium-type pricing always postulates preferenceparameters like risk-aversion and time-preference. In general, and please correct me if I am worng, I believe there's nothing in this general theory to prevent these from changing dramatically, let's say every day. Given that, then "rational" traders can create whatever volatility they want . If a particular theory leads to predicting dramatically lower volatility than what is observed, I would guess it's because it doesn't allow for changing preferences. So the silly part seems to be neglecting changing preferences and then concluding "irrationality". Maybea better adjective would be "wrong-way conclusion". The effort itself of trying to construct a volatility theory is certainly not silly. <i>Here you have made a dramatic change to the market micro-structure. How much of the change in volatility will be due to the change in market micro-structure? How much to the trading? </i>By "trading", I really just meant this change in the market micro-structure. So my question is really about the amount of volatility that peoplebelieve is due to that. Thanks for helping me clarify that ambiguity.
Last edited by
Alan on January 9th, 2003, 11:00 pm, edited 1 time in total.