Virtual currencies: From search for yield to search for volatility - Nomura

With investors seeking investments generating higher returns in a “search for yield”, volatility has been declining in many asset classes, according to Takahide Kiuchi, Executive Economist at Nomura.

Key Quotes

“In such a market environment, investors preferring high-risk, high-return investments look more aggressively for highly volatile assets from which they can expect capital gains in the short term. This “search for volatility” investment behavior has recently focused many investors’ attention on virtual currencies. Indeed, trading volumes for virtual currencies are rising at an astonishing pace. However, this rise in trading volume is increasing the liquidity of the virtual currency market, which could lead to lower volatility.”

“If that occurs, virtual currencies will lose their investment appeal and volume expansion will be suppressed, presenting something of a predicament. On the other hand, if we consider virtual currencies’ lack of a clear pricing standard, a special feature of this new instrument, volatility could remain high even while trading volume expands. Which direction virtual currencies take as an investment instrument could have important implications for the investment environment in all financial markets.”

“High volatility is a special feature of virtual currencies

• When considering virtual currencies, such as bitcoins, as a financial asset investment target, their most salient characteristic probably is their high volatility. This high volatility is made even more prominent by the decline in volatility for many other asset classes. High volatility implies high investment risk and, at the same time, a high potential return. As a result, virtual currencies are becoming an attractive investment for many investors who favor a high-risk, high-return investment style. 
• With no clear signs of an end to the current low interest rate environment, many investors seeking income gains have been aggressively channeling their fund flows into high-yield bonds with high credit risk profiles. This investment behavior is referred to as a “search for yield.” However, the growing prevalence of this investment behavior has been pushing down yields on a variety of securities, driving the interest-rate differentials, or spreads, between these instruments and superior creditworthy government bonds to historically low levels. This has greatly reduced opportunities for investors to generate income gains.”