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A storm was brewing as the price of oil declined from its peak at $26 a barrel in January of 1997 to just below $11 a barrel in December of 1998, a decline of nearly 60%. With a high fiscal deficit from the first war in Chechnya, high exchange rates, and a declining stock market, the Russian government decided to intervene.

To negate capital flight, in June 1998, interest rates on GKO bonds (short term, zero coupon bonds) rose to 150%. On the 17th of August 1998, the Russian government defaulted and restructured its debt. The exchange rate went from 6.4 Rubles per dollar to 20.8 Rubles per dollar, a 225% increase in merely 16 days (09/08/1998).

During this time, Long Term Capital Management, a former titan on the street, began to experience severe pain. Market participants began to look for liquidity, with most of LTCM’s trades being in illiquid instruments, price levels of its assets began to sink, which led to forced selling of its more liquid equity trades at a steep discount. From the start of September, LTCM’s equity went from 2.3 billion to just 400 million by September 23, 1998, at this time, LTCM was levered 250-1.

Volatility rose sharply during this period as investors began to speculate on Russian intervention, peaking on the same day the S&P 500 would find a bottom, over 22% off its recent high, in only 57 days. While the rise in volatility was significantly slower than those in more recent history - post-2008 - the retraction from highs does support our expectation that, regardless of the root crises, volatility remains a dependable, mean-reverting asset.

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Sources: Bloomberg Finance