Anyone knows Why are equities and volatilities negatively correlated?
Thanks.
I’ll try to put it this way. If someone can confirm or explain better, please do so:
Don’t know if this statement is true for every company but I’ll try to put it this way: Most companies (when performing poorly) usually try to access capital through debt (i.e. leverage themselves) as this is cheaper way of gaining capital. This increased level of leverage (especially if the optimal amount of leverage was exceeded) will increase the volatility of equity of the company, and this volatility, if persisted for a period, will put a downward pressure on the returns.
Looking from the other angle, I would also say that in the periods of hightend volatility there is a flight to quality moment, meaning investors would shift their money from equity investments to bonds as there is a highly negative correlation between stocks and bonds in such periods. And if there are more people who want to sell the stock (than the ones who want to buy it), this would also lower the price of the stock.
If anyone knows better or can correct me, please be free.
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Higher volatility equals higher risk. Higher risk requires higher costs of capital. Higher costs of capital equal lower valuations.
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