2005 was a year of compressed volatility. Outside of the commodity markets and their attendant equities, the stock market was frankly a dull place. Daniel Gross at Slate.com asks where has all the volatility gone?

There are a handful of theories as to why volatility is so low. For one it is possible that the markets (and the economy) simply are more stable and deserve lower volatility. Second, it could simply be the case the markets have become better at incorporating important information in a timely manner making rapid run-ups in prices less likely. Third, and maybe, most likely is the fact that the vast savings glut has injected enough capital into the system to make prices less volatile.

Speaking of volatility, The Stalwart has little faith in the use of plain old standard deviations in portfolio planning. Their thinking is that real-world distributions are less than normal making the clean assumptions of normal returns highly unlikely.

Justin Lahart in the Wall Street Journal also notes the low level of market volatility, and the relationship between the VIX and the yield curve.  For example when the yield curve is flat, i.e. now, the VIX tends to rise in the future.  It is an interesting theory and one that points to taking less risk in 2006.

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