Sunday Review: Robert Whaley

Robert Whaley is a professor of finance at Vanderbilt University’s Owen Graduate School of Management and the developer of the two major so-called fear indices — the VIX and VXN on the Chicago Board Options Exchange — that are used to make bets on market volatility.

READING Right now it’s “Becoming Steve Jobs,” by Brent Schlender and Rick Tetzeli. It has a somewhat different take than Walter Isaacson’s “Steve Jobs.” I felt Isaacson’s version was a little negative. But what the books have in common is that Jobs was sheer genius. So what if he was arrogant? Consider what he’s done. We wouldn’t have iPhones and iPads if it wasn’t for his vision. I absolutely think that excuses his behavior. If everyone just wanted for people to look back and say you were kind, how would we move forward?

LISTENING On my iPhone are 55 albums by Bob Dylan, 16 albums by Leonard Cohen and 34 albums by Steve Earle. That’s all I listen to. It’s the storytelling in their lyrics. Dylan’s album “Tempest” is one of his best. The title song is a haunting 14-minute song about the sinking of the Titanic. I have every one of his albums except the last one where he interprets Frank Sinatra. That was out of line. He must have needed money. And I actually bumped into Steve Earle at the airport and introduced myself. My wife was just disgusted that I’d go and bother him, but he was very receptive. No, I did not tell him I developed the volatility indices.

WATCHING Currently, it’s “Wallander,” which is a BBC crime-detective show. The main character is gruff and very deliberate in his actions, like the lead character in “Ray Donovan,” another great show. I’m also Canadian and a sucker for a good love story, so I enjoyed “Last Tango in Halifax,” which is about a couple who were in love in high school, separated and then reunited in their 70s. I guarantee it will bring tears to your eyes.

FOLLOWING Through the digital library JSTOR, I have online access to hundreds of finance and economics journals. There are many articles written on volatility, but often they try to come up with more and more sophisticated statistical models, which don’t capture what’s at the heart of the problem. It’s a Chicken Little mentality caused by one piece of information, like the market slide in China, getting reported and re-reported and each time exaggerated a little bit further and then you saw what happened — a 1,000-point drop in the Dow. It’s kind of frightening.

TRADING The amount of trading going on is just much too high in my view. With automated algorithmic trading, we’ve gotten ourselves into a bit of a pickle. I was reading that some hedge fund made more than $1 billion as a result of the recent market dive by essentially trading on volatility. They made a bunch of money because everyone overreacted. I didn’t see the spike in volatility coming so I got hammered.

PUBBING My wife and I have a passion for Ireland and travel there at least twice a year. We enjoy the Irish people and the music so much, we built an Irish pub in our basement. Naturally Guinness is on tap, as are Harp and Kilkenny. When I teach, I bring the whole class over one evening, and it’s usually the thing they remember from going through the M.B.A. program. St. Patrick’s Day is our biggest celebration with more than 60 people enjoying Guinness stew, shepherd’s pie, seafood chowder and Irish brown bread, which my wife and I prepare. If you want to see it, our son created a website:


How To Manage This Week’s Unprecedented Volatility

In an interview yesterday on Marketplace, Robert Whaley, father of the Volatility Index (VIX) that measures whether or not there is too much fear or optimism in the financial markets, said that at the “beginning of the week VIX was about at a level of 12, at the end of the week it was at 28. That was the biggest percentage increase the VIX has ever had in its entire history.”

Whatley added that the VIX is “a measure of the volatility you expect over the next 30 days.”

If he’s right, the next month is going to be extremely volatile. This not only applies to the stock market but also to our world in general.

This leads me to a non-intuitive lesson I learned years ago: in volatile times, too little risk is dangerous.

To illustrate, let me use a silly example…

Zombies take over the world, causing chaos to reign. In panic, you take all your money out of the bank and hide it under your mattress. Zombies burn down your house, and you are left with nothing.

In retrospect, you could have left some money in the bank. You also could have – in no particular order – moved some money to: gold coins, canned food, an anti-Zombie ray gun and panic room, and a few bank accounts on island nations like Australia, where the zombies have not yet spread.
Back to the real world. This line of thinking is described in the book Real Options by Martha Amram and Nalin Kulatilaka. The book explains that “an option is the opportunity to make a decision after you see how events unfold.”

Imagine if you could place a bet on a blackjack hand after you see which cards you are dealt. That might be slightly more profitable than betting ahead of time, wouldn’t it?

Here’s more from the book:

On the decision date, if events have turned out well, you’ll make one decision, but if they have turned out poorly, you’ll make another. This means the payoff to an option is nonlinear — it changes with your decision.

The way to put this advice into action is to adopt the following mindset:

Preserve your options as long as possible.

If you’re not sure whether or not your company will survive the next six months, don’t just quit and look for a job. Instead, keep doing your job but also start networking like crazy and unearth other potential employment. Let’s say this takes three months. At that time, you may have several options:

1. Stick with your current job.

2. Take job offer A.

3. Take job offer B.

4. Take consulting opportunity C.

Volatile times create opportunities, but only for those who have kept many options open. It is highly dangerous to enter such times with only one or two options.

This line of thinking applies to almost any profession or personal situation. Unless you can see with absolute certainty your next 20 years, it will be in your interest to preserve as many options as possible. Pick up new skills, make new connections, and diversify your investments.

But when China’s growth is dropping off a cliff, oil is less valuable than water, and the Dow Jones Industrial Average (DJIA) bounces around 600 points on a daily basis… you can’t afford to take too little risk.