Hope trend, drift rate and Weiner Process

In all the business management courses across the world, the book Options, Futures and other Derivatives by John C Hull is a mandatory read. The author writes in detail about the mathematical processes which describe the movements of asset prices. The attempt obviously is to improve upon the random walk model and provide it a defined structure. One process which is used often in the book goes by the name “generalized Weiner process or GWP”. Generalized Weiner process essentially says that any asset price movement rather than being completely random, consists of two parts firstly a drift rate and secondly a variance rate. The former is the trend whereas the latter represents the short-term movement.

In the field of market analysis as the short-term movements are almost unpredictable (close to random walk), it helps if one can develop a faculty to spot the trends and its changes, that is the drift component of GWP. Now how to do that?  This change can be discerned if we follow the market chatter closely. The chatter or discourse can be on social media or financial news or anywhere else. Slowly the pattern of change emerges, however only after some time one can look back (with the benefit of hindsight) and clearly locate its trajectory.

The change in discourse which we are witnessing in the markets currently is that the chatter is increasingly moving to the hope predicated on the vaccine. The uncertainty surrounding the vaccine development is now giving way to discussion about what is the mechanics and how it will be mass distributed. Finer details about the cold storage temperature settings, recipient prioritization, usage approvals, cost implications are slowly emerging. Analysts will now start writing that how the operational challenges need to be overcome and how a mass immunization program can be a success. This signifies that a trend of hope is getting established, in global market terms we can call it a “secular risk on”. Readers would do well to note that the day to day movements will still remain unpredictable, but this is more about getting the drift. Pun intended!

So how does this play out? Safe haven assets like Dollar, Yen, gold and US treasuries will retreat. Equity markets in general, Oil, EM assets should gain. In case the pandemic stimulus in the US or Brexit deals finally materialise, they are expected to add to the optimism. The only spoke in the wheel can be a statement by the central banks where they express concerns about over heating of the economies. But as we had written about the “long term, all in” commitment by Fed chief yesterday, the CB concern looks sometime off.

Domestically the Rupee has opened at around 74.30 and the 10-year bond has opened flat. Today we have the special OMO auctions where RBI will purchase long-term securities and sell short-term treasuries, each leg for 10k Cr INR.