Pricing for Perfection

Abstract

In this speech, given to a group of market participants, Sir John Gieve — Deputy Governor for financial stability — cautions that with implied volatilities and risk premia low by historic standards many markets appeared to be 'priced for perfection'. He notes that one factor that may have been driving down implied volatilities was the apparent popularity of selling deeply 'out-of-the-money' options, which equates to selling insurance to others against unlikely financial market events. He concludes that given the rapid pace of innovation in financial markets and products, investors need to take particular care to understand the risks they are exposed to, and suggests that one approach would be to put greater emphasis on stress-test results as well as more conventional risk metrics.