Question

You and a colleague both follow the movements of the VIX, an index based on options prices that reflects investors’ expectations for stock market volatility. Suppose, according to the VIX, implied volatility is expected to be low for a protracted period. Your colleague sees this as unambiguously good news. Why might you disagree?

While you agree with your colleague that low levels of implied volatility might bring   (Click to select)   high   low   unchanged  stock valuations and a   (Click to select)   high   low   unchanged level of stock market liquidity, you might be concerned that investors will become complacent and   (Click to select)   underestimate   overestimate  risk, causing risky assets to become mispriced and possibly destabilizing the financial system when prices correct.

Answer 1

Answers in bold. Explanation in parenthesis.

While you agree with your colleague that low levels of implied volatility might bring unchanged (a low volatility means that the prices wont move much in either side) stock valuations and a high (stock liquidity means ability to buy stocks without affecting its price. low volatility enables that) level of stock market liquidity, you might be concerned that investors will become complacent and underestimate (low movements will cause investors to think the risk is low) risk, causing risky assets to become mispriced and possibly destabilizing the financial system when prices correct.