Extreme Risk: Global Market Risk

There are a million ways to measure financial risk, and if one wants to calculate global risk, it requires a truly heroic set of assumptions. But it's much easier to calculate global market risk, and that is what I set myself to do below.

So what is the difference between global risk and global market risk? Market risk only captures day-to-day risk in equity markets. It misses out on all the illiquid and nontransparent loans and hopelessly complex derivatives and all the other myriad parts of the financial system.

It is not possible to calculate global financial risk.

Market risk, with its emphasis on day-to-day outcomes equity markets, is much easier. Just know what you are getting into.

Start with the main stock market index in each country and wield the riskometer, the device used to measure market risk. I'm using the six most common, see, each with their own pros and cons.

Having obtained the national market risk, I then take the GDP weighted global average for the G20 member countries, and that gives me global market risk. It is a number between zero and 100, with zero being no chance of loss and 100 all the money in all the world stock markets is fully wiped out.

Global market risk

At the latest observation, September 22, 2022, GMR is 3.38. The three most dramatic GMR events in recent history, the 8.9 on 27 October 1987, 9.3 at the height of the global crisis in 2008 (31 October 2008) and 9.1 when the Covid 19 crisis was at its worst on 17 March 2020.

There are two bits of technical details worth mentioning, which actual riskometers are used, and how GMR compares to the VIX.

Comparison with the VIX

The most obvious alternative to the GMR estimate is the VIX, the most commonly used global risk measure. It is so popular it even got its own thriller, Robert Harris's The Fear Index. Many academic papers tell us how the VIX affects capital flows and asset allocations throughout the world.

The VIX isn't a very good measure of global market risk even though many people use it that way. It is the one month volatility of the main US stock index, the S&P 500. As such, it is both dependent on the US markets and even worse, on volatility being a good measure of risk.

Well, it isn't, because financial returns have fat tails.

Because the VIX is a one month volatility, and the typical trading month has 21 days, I take my GMR index and multiply it by the square root of 21 sice the typical number of trading days in a month. The numbers look similar, but certainly not identical.

US market risk and VIX in 2020

Extreme risk

Daily market risk forecasts and analysis
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