Risk and Ambiguity in Turbulent Times

Abstract

This paper focuses on the 2008 to 2020 period during which two major crises, affecting the economy and the financial markets, occurred. Between 2008 and 2020, there were less extreme tail events, including the lingering Eurozone and Greece crises. In particular, after extremely high stock market volatility and volatility of volatility (VoV) during 2008, the long-run average volatility declined to about 20% and the VoV to around 100%. This paper analyzes this period through the lens of risk and ambiguity (uncertainty). It aims to address the question: what are the financial markets that trade risk---the volatility derivatives markets---telling us? To this end, this paper uses several measures of uncertainty. This paper reviews the history of volatility and uncertainty measures and discusses their informativeness. It then discusses the information derived from volatility derivatives.

Keywords: Ambiguity, Knightian Uncertainty, Financial Crisis, Covid Crisis, Volatility Index

JEL Classification: D53, D81, D83, E44, G1