Kai Ryssdal: What I'm about to say may sound counter-intuitive, but pay no attention to the Dow. Not the Nasdaq or the S&P, not the Wilshire 5000 or the Russell 2000.
You want to know what's going on in the markets? Dial yourself over to the Chicago Board Options Exchange and check out something called the VIX: the Market Volatility Index. It measures -- almost literally -- how freaked we really are. It looks at how investors feel about the future volatility of the markets by measuring what kinds of precautions they take to protect their portfolios, their investments.
Robert Whaley is a professor of finance at Vanderbilt University. He's also the father of that fear index. Welcome to the broadcast.
Robert Whaley: Thank you.
Ryssdal: So the VIX, as it is, is a phrase being thrown around fairly freely these days, as I'm sure you've seen. I wonder if you could tell us what it's really supposed to measure, though?
Whaley: It's supposed to measure what volatility investors expect over the next 30 days. And volatility is a measure of the swings, if you like to see swings, as we have in the past couple of weeks or so.
Ryssdal: Seems like kind of an interesting experiment: quantifying what -- if you look at a chart of the Dow, for instance -- we all feel in our gut.
Whaley: It is, it's a measure of the price of portfolio insurance. I mean, we all have equity portfolio investments in one way or another, and at times like this, you're concerned about losing a lot of their value. You have two options: one is that you can get out of stocks and buy Treasuries; the other thing you can do is buy insurance. If you buy insurance, you're buying S&P 500 puts. The more puts that are purchased, the higher the price goes.
Ryssdal: Explain that in layman's terms, would you?
Whaley: Suppose that you owned a house on the North Carolina beach. You don't have insurance on it, and you know insurance is $500. Then you become aware there's a hurricane off the coast, and you have a great likelihood of getting hit. Chances are, you're going to pay more than $500 for the insurance, and that clamoring for insurance, given the increased odds of some disaster happening, is going to go way up. And so what you're seeing is investors being anxious about the value of the stocks they have in the portfolio for their pension and retirement, so they're willing to pay more and more for insurance. The VIX is simply the price you're paying for that insurance.
Ryssdal: All right, well let me ask you this, then: Is it not possible that knowing what's coming creates more volatility than a rising VIX creates a rising VIX?
Whaley: Oh, can you frame that question a little differently?
Ryssdal: Sure. Is it possible that this thing, knowing how nervous people are, makes people more nervous?
Whaley: Um, that would a behavioral type of interpretation. What makes me more nervous, actually, is sort of the movements that we're seeing in the stock market on a daily basis. This VIX is just telling you that they suspect those types of movements to persist. But yes, I mean, you're seeing that the price of insurance is going up, and so it makes you wonder, if you're seeing the price rise, whether people smarter that know there's going to be an event, so you might jump in too.
Ryssdal: Well, you know, it's interesting that you mention the event coming, perhaps, because I'm looking at a chart now of the VIX, and it goes back seven years, I guess. Right in the middle is a huge spike, when Lehman Brothers went under in 2008. And if you look at the VIX today, it's trending upward along those lines.
Whaley: You have to put things in perspective, too. The VIX has spiked many times over its history since 1986. The highest level it got to was 170-plus in October 1987. So, the level you see it at now, I don't know, I think it's hovering at about 41, it's not that large.
Ryssdal: Do you watch CNBC at all?
Whaley: I do.
Ryssdal: So what do you think of when they spend minutes on end talking about the VIX doing this, the VIX doing that? Is it serving its purpose, do you think, when it's used that way?
Whaley: I think it's serving its purpose. I view as a measure of how anxious people are feeling about the stock market. And if you look over the past few months, they weren't all that anxious. And just by glancing at that number and looking at it relative to its historical levels, you know something's going on.
Ryssdal: You know what it reminds of a little bit? It reminds me of the stories you hear from the old days when they didn't have weather satellites, just to get to back to your hurricane example. And you didn't know what was coming.
Whaley: Exactly. That's a good analogy.
Ryssdal: Well good, feel free to use it.
Whaley: I will!
Ryssdal: Robert Whaley, professor of finance at the Owen Graduate School of Management at Vanderbilt University, the inventor of the VIX. Prof. Whaley, thanks so much for your time, sir.
Whaley: Thank you.