New IIF U.S. Market Risk Index Sends Warning Signal

September 04, 2014

Washington, D.C., September 4, 2014 - Investors should be more cautious as market uncertainty rises in anticipation of the Fed's first rate hike next year, according to a new index developed by the Institute of International Finance.

"In light of the pending Fed exit from quantitative easing and the associated potential market risks we are offering a simple, intuitive gauge that we think is a helpful alternative to the VIX," said Hung Tran, executive managing director at the IIF. "Currently, the IIF U.S. Market Risk Index reflects a degree of stress building up: equities continue to gain over bonds, while the dollar index has had a decisive move higher since early July. Hence while volatility-based risk measures still show a green light, our new index suggests more caution may be warranted."

The IIF U.S. Market Risk Index (U.S. MRI) is derived from three easily understood factors in the context of market risk:

  • The degree of outperformance of equities over bonds;
  • The BBB credit spread over Treasuries; and
  • The U.S. dollar index.

The VIX is based on the implied volatility of S&P 500 options and is widely used as a gauge for risk in equity markets.

The IIF noted that given the inherent shortcomings of using volatility as a proxy for risk tolerance/aversion, the U.S. MRI takes a different approach: instead of using bets made in derivatives markets to infer investor sentiment, the U.S. MRI uses underlying asset price movements.

The IIF also noted that like its medical namesake, the U.S. MRI effectively images different market sectors, creating a more holistic view-in this case of investor sentiment and behavior. The emphasis on the behavioral component in investing is another distinguishing feature of the new index.

The U.S. MRI will be updated on a daily basis and will be available, after an initial comment period, on the IIF website (www.iif.com) and the Bloomberg terminal in the IIF page at IIFR. Market risk indices for other regions and countries are under development.

The U.S. MRI was introduced in the September edition of the IIF's Capital Markets Monitor.

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The Institute of International Finance is the global association of the financial industry, with close to 500 members from 70 countries. Its mission is to support the financial industry in the prudent management of risks; to develop sound industry practices; and to advocate for regulatory, financial and economic policies that are in the broad interests of its members and foster global financial stability and sustainable economic growth. Within its membership IIF counts commercial and investment banks, asset managers, insurance companies, sovereign wealth funds, hedge funds, central banks and development banks. For more information visit www.iif.com.

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