Q&A with Peter Lung, associate professor of finance
Peter Lung is the Denver Clearing House Endowed Chair in the Reiman School of Finance. For more than 18 years, he has studied the volatility index (VIX), which uses the S&P 500 to measure whether the financial market is calm or nervous. Also known as a “fear index,” the VIX jumps whenever the market risk and probability of a crisis increases, as it did for the first half of this year, when an interest rate hike was uncertain.
More specifically, Lung studies the volatility of the volatility index. He has studied VIX levels spike during notable events like the 2008 subprime mortgage crisis, Brexit and COVID-19. His work has been published in the Journal of Financial and Quantitative Analysis, Financial Management and the Journal of Banking and Finance. In an email interview with the Daniels Newsroom, Lung used his research to examine inflation, the stock market and the possibility of a recession.
Given your research, what do you think about a coming recession?
If we only use VIX and VIX futures, the market seems optimistic, even though inflation may not drop any time soon. Despite VIX moving, the volatility of the VIX has calmed down since July 2022, indicating the market has mostly done its hedging based on the current microeconomic indicators. Hence, I am not pessimistic even though(?) the inflation may not drop in a couple of months.
Given your research, what do you think about inflation?
According to the bond derivatives market, the inflation is expected to be the same or drop. The chance for the inflation spikes is slim. Fixed income derivatives are interest driven, while interest rates and inflation usually move at the same time. It’s why these derivatives capture the market expectation about inflation.
Do you think the Federal Reserve is taking positive steps to curb inflation?
The Fed may be a little be late, but I think its action to increase interest rates is better than doing nothing. I think the Fed can curb the high inflation by the end of this year.
How are ordinary investors having an impact on the stock market?
Individual investors have been changing investment behavior since 2008. In the past, financial gurus from big institutions could easily mislead individual investors. As individuals listened and followed the comments from those gurus, they usually were scared and cut losses, while institutional traders were waiting to take the advantage as the market was in panic sale. However, there were several cases showing individual investors becoming more rational, such as the GameStop short sale case and the market reaction to COVID-19 in 2020.
Any advice for investors?
I would say investors should always consider hedging their risk. I saw many investment strategies that can yield 100% in a year, but I seldom saw very prudent risk management that is the key for long-term success.
As Warrant Buffet says, don’t try to time the market. No one can predict accurately every time. The above is my opinion based on the most recent information in the market. Get ready to hedge!