The ‘Fear Index’

BlackRock

Earlier this year, in February, the financial press started to relay a warning issued by BlackRock, the world’s largest investment management corporation. BlackRock Managing Director Martin Small particularly warned clients against ‘leveraged and inverse VIX-tracking ETPs’. He demanded a better differentiation between ‘plain vanilla’ exchange-traded funds (ETFs) – that BlackRock deemed more safe and more adapted to resist to market shocks, and these ‘engineered’ exchange-traded products (or ETPs) – that he considered a systemic risk. Behind the lively tone and The Big Lebowski’s jokes, and although Small did not name any specific products, it was clear that what was targeted was derivatives betting on the fluctuation of the Vix, a volatility index peculiarly nicknamed ‘the fear index’ in financial circles and which is, at the moment, at the centre of financiers’ careful attention.

Without discussing the intricacies and technicalities of the products offered by the financial world, nor their alleged safety, what is interesting here is that a mammoth company like BlackRock — whose chief strategists’ expertise is highly regarded and eagerly followed within the financial community — is getting increasingly uneasy about the few derivative products that gravitate around the Vix. This unease (not to say panic) seems currently widely shared among finance experts and in the specialized media, if we consider the constant stream of news articles and columns published about this all throughout 2017 and 2018.

The recent financial unrest seems to prove them right as Small’s post was published two days after an extremely violent flash crash. On the 5^th February 2018, after a day of intense turmoil, an estimated $3,000 billion of capitalization was erased, followed by 2,000 billion on the 8^th in a self-perpetuating cycle. Everybody seemed to agree that the Vix was the primary cause of this financial debacle.

The Vix: the ‘fear index’

But what is the Vix? The Vix is an index that measures the market’s expectation of future volatility over the next 30-day period. It was created in 1993 by the Chicago Board Options Exchange (Cboe) and it is calculated from Standard&Poor 500 option prices. It often moves inversely to the S&P benchmark, which means that when prices of options go down, the Vix goes up. Because it can signal sharp surges in prices that result from panic movements on the stock market, the Vix has quickly internally passed from a volatility gauge to a ‘fear’ gauge that allows investors to assess the state of minds of the other investors, and their stress.

To give a basis for comparison, the Cboe Vix Index charts indicate that, since its creation, the Vix ordinarily fluctuates around a level of 15. An index level of 30 is seen as an indication of ‘serious market unease’, whereas 40 clearly signals a crisis. As an illustration, the Vix reached 90 during the 2008 banking crisis, and it peaked at 37.32 on the 5^th February 2018. By contrast, in January 2018, the Vix Index strangely remained at historically low levels passing several times under 10.

Most of the news articles published before the February flash crash marveled about what the Financial Times has called the ‘enigma’ of the low Vix . What financial observers could not understand was why the Vix was so low considering the larger global political uncertainty (e.g. Trump’s unpredictable policies, the tensions with Russia and North Korea, to name just a few). The discrepancy between a low Vix rate – that indicated some level of confidence that no serious financial turmoil was in sight – and the general level of political unrest started itself to be an object of disquiet. Either it signaled a disconnection from the ‘real world’ – similar to the one that led to the subprime mortgage crisis and fed by the unconventional monetary policy of the central banks. Or it was due to the fact that the Vix was being kept artificially low because of mechanisms internal to the financial market; which in turn meant that the Vix was not a reliable measurement of investors’ anxiety anymore.

Vix-tracking derivatives were specifically a cause for concern. As an index, the Vix cannot be directly bought or sold. Nonetheless, since 2004, Cboe has allowed the development of a derivative market based on the Vix – with Vix futures (used by traders to insure risky positions in case volatility should unexpectedly rise) but also with the inverse VIX ETFs denounced by BlackRock, like Crédit Suisse XIV. These ETFs bet on the long-term perpetuation of a historically low Vix and thus used to be extremely lucrative, until this fateful February. Trading these derivatives eventually amounts to trading volatility and, as such, represents a problematic step up in market virtuality, even to the usual advocates of financial trading. As Financial Times columnist John Dizard claimed “volatility is an attribute, not a set of objects or financial claims”; it is difficult to give it an objective value. This highlights, in short, the difficulty in giving a price to intangible feelings and impressions since there is by definition no underlying asset to justify this evaluation.

Secondly, many like Dizard started worrying about the tremendous sums which had been invested in inverse VIX ETFs. Since the Federal Reserve was announcing the end of its accommodating interest policy, prices were bound to rise and with them volatility and the Vix. In the advent of even a moderate rise of the Vix, an important amount of market capitalization would be obliterated because of the inverse VIX products. This obliteration would cause important systemic risks since it was likely to lead to a self-perpetuating cycle of losses. Investors would sell option assets en masse to cover their losses, leading subsequently to a fall of option prices and a further rise of the Vix, and thus to further losses – etc. This is what eventually happened on the 5^th and 8^th February

The ‘fear index’ in the financial imaginary

This was a quick summary of the ways the Vix works (or rather doesn’t), but my point is not to merely critique the way the Vix is traded upon. What I want to demonstrate is how the ‘fear index’ is representative of the ways the social imaginary of finance inherently functions and particularly how it has a tendency to work toward its own self-destruction.

Castoriadis’s work is particularly useful to illustrate this and I will thus give a quick reminder of his theories. First, according to Castoriadis, social imaginaries are meant to provide creative solutions to societies’ existential problems. In his Imaginary Institution of Society, Castoriadis discusses Levi-Strauss’ work on the ‘functionality’ of social organizations. According to Castoriadis, if every society obviously fulfills certain core functions – like production, reproduction, education-, they all perform them in different ways (p. 174). These self-creative variations are what Castoriadis wishes to capture with his concept of the ‘imaginary’. The imaginary is what enables a society to define its relations with the world, to express its ‘needs and desires’ (p.221).

Nonetheless, the imaginary as a force of creation remains fundamentally ambivalent because of its inherent connection with alienation. Because the imaginary often takes precedence over considerations of functionality, sometimes the imaginary solutions (or institutions) can become a-functional as they start undermining the workings of society’s vital functions (p.173). This especially happens when the imaginary becomes autonomous from society’s creative agency; that is, when societies seem to forget that they created these institutions and that they can therefore amend them to follow their functional needs. Castoriadis gives the 19^th century crises of overproduction as an example of how societies may be “overwhelmed by the logic of their own economic institutions” and thus unable to mitigate their negative effects (p.185).

In his essay “Les Significations Imaginaires,” Castoriadis argues that, in order to prevent this degeneration toward heteronomy, societies should seek to keep a certain leeway with their imaginary creations, mainly by keeping alive the creative impetus of what Castoriadis calls the ‘radical imaginary’ and by constantly displacing and questioning the crystallization and rigidity of the ‘instituted imaginary’ (that is, the institutions once created by the radical imaginary).

Return to the fear index

These three dimensions are strikingly at work in the financial imaginary with the ’fear index’.

First, the ‘fear index’ appears as a creative solution to the problems identified by the social actors of the world of finance. The Vix represents primarily an attempt to ‘hedge’ — that is to insure oneself — against risk (as Vix futures explicitly aim to do). As such, the Vix is the concretization of the old neoliberal fantasy of finding market solutions to all social problems. Here the problem at hand is how to foresee investors’ panic that leads to financial crash. From this perspective, the Vix’s inventors claimed to have imagined and created an algorithmic model that could translate investors’ intangible sentiments and moods into a simple numerical representation. Thanks to it and throughout a long learning process, by observing the fluctuation of the ‘fear index’ in correlation with other financial indicators, like the global yield curve, analysts could learn to spot the first signs of a coming crisis and make provisions for it. From this perspective, the creation of the Vix illustrates, at first sight, the extraordinary creativity of the actors of the world of finance, as well as the ability of finance to always renew itself.

However, the Vix also appears as the perfect illustrations of a now autonomous imaginary that has got out of control, turning against its own creators. Whereas it was supposed to model fear in order to protect the financial world from risk, it ends up representing a systemic risk and thus to become itself an object of fear. As Brean Capital analyst Peter Tchir said in the Financial Times: “There is one thing that Wall Street does with uncanny frequency — it turns a good and profitable product into something dangerous as its life cycle goes on”.

Castoriadis differentiation between the radical and instituted imaginary can explain how and why the Vix has escaped the control of its creators. While the Vix might have been a radical imaginary solution to escape the loop of crisis, it has become so instituted as to crucially become a criterion for pricing and an object of trade, thus weakening the Vix’s alleged reliability in neutrally reflecting investors’ fear.

Starting with pricing, it is quite clear that the Vix rate is now largely integrated to the pricing of options. However, its rate is itself based, at the very same time, on the prices of those options. These self-referential indexes thus prove Michel Callon and Donald MacKenzie right when they claim that economics is not simply descriptive, but fundamentally performative. In other words, measurement is not neutral but, on the contrary, alters its object. When trying to measure the agent’s emotions, the Vix thus also alters their perception and feeling about the market, producing further panic or further apathy.

Moreover, once the Vix – and by extension volatility — starts being indirectly traded within a specific derivative market organized around it, it becomes necessarily caught in the loop of imitative mimetic phenomena, which in turn causes important systemic risks in the event of a market upturn. The rush toward lucrative inverse-Vix products and the subsequent mass panic movement on the 5^th and 8^th February illustrate well the risks of imitative behaviors driven by the desire to make quick profits.

Once the Vix becomes an instituted numerical value that can be easily used and exchanged, it starts defeating the initial aims of its creators. It is taken over by the autonomised logics of the financial imaginary and works toward its ineluctable implosion.

Conclusion

To conclude, the inherent tendency for financial instruments, such as the Vix, to escape human agency results from the peculiar relation that the financial imaginary has with the act of creation. According to Castoriadis, the radical act of creation should continually be renewed to prevent the imaginary from becoming autonomous in its instituted form. However, in the case of the financial imaginary, the actors of the world of finance freeze this creative moment to apply the algorithmic formula thus created in a settled and instrumental form. This leads in turn to the autonomization of those formulas, and with it, to important systemic risks.

In other words, the self-defeating mechanisms that I just highlighted are not exclusive to the Vix, but are characteristics of all financial instruments in general. Although the creation of new financial instruments might represent an attempt to creatively adapt to an unstable environment, these instruments are soon to be taken over by the internal logic of the financial imaginary – a hubris which turns any creation into new instrumental opportunities for profit, resulting in their ineluctable implosion in yet another speculative bubble.

Carla Ibled is a PhD candidate at Goldsmiths College. Her current research explores the imaginaries of neoliberalism, drawing on political theory, psychoanalysis (and the work of Cornelius Castoriadis and Jacques Lacan in particular) and economic history.