Tuesday, June 8, 2010

Volatility Villains

This article, in the most recent issue of Barron's Magazine, says that "the biggest floating crap game" is run on Wall Street. 

In the article, there's a good graph in the article that illustrates how much volatility has changed in recent times compared to the past twenty years. Later in the article, Kevin Cronin, director of Global Equity Trading at Invesco asks a key question:

"Do we want a casino, or do we want something that fosters longer-term investment and capital formation?"

The primary argument for all this extreme trading has been that it adds liquidity.

As a result - the argument goes - this supposedly benevolent added liquidity will make stocks less volatile. I think there's evidence that this is not necessarily the case. One thing that isn't in question, all this liquidity adds a bunch of frictional costs that, by definition, hurts investor returns in the aggregate over the long run.

It also reduces confidence in the stability of the system which almost certainly leads investors to get out of the market at just the wrong time out of fear and vice versa.

Check out the full article.


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