A relatively high level of volatility has been prevalent in the financial markets ever since the credit crisis broke last year. It has waxed and waned, of course, as events have unfolded, but remains elevated. And, unfortunately, the outlook is that it is unlikely to diminish to the comfy levels recorded in the quiet years before the crisis got under way.

Actually, the word "unfortunately" may not be entirely appropriate. There are traders and investors who thrive in a volatile environment, and look forward to experiencing more, rather than less, turbulence. On the other hand, for those without strong stomachs, it can be upsetting.

Just to get a perspective on the current situation, cast your mind back to the pre-crisis period. That was a time of calm seas and blue skies. In general, both implied and realised volatilities were exceptionally low.

Most people on Wall Street and beyond thought they had become masters of risk management. And central banks, the Fed in particular, believed that having discovered the magic of policy fine tuning, they could readily achieve the goldilocks scenario of high growth and low inflation indefinitely.

Unhappily, the big bear showed up, finished off goldilocks and put an end to the ridiculous illusions and the widespread self-deception. The arrival of the bear shouldn't have come as a total surprise to those who had taken account of the US housing bubble, its interconnection with the financial system, the growth of the shadow banking sector, and years of policy mistakes by the Fed in puffing up the balloon.

Now that the US economy, and much of the rest of the world, is in the worst recession experienced in decades, governments are at centre stage trying to reverse the situation. Both the monetary and fiscal authorities are engaged in implementing policies to rescue the banking system, furnish liquidity by a variety of means, and increase government spending. And nobody has acted more aggressively than the Americans.

The problem is that we are suffering a crisis, primarily caused by policy mistakes of the past. As for the forward outlook, there will be more unpleasant consequences from the errors committed by policymakers in the present. Their quandary is that, politically, they have no choice but to be very proactive. They do not have the luxury of mulling over pros and cons.

The consequence of their actions is that volatility is exacerbated rather than dampened. Market participants try to guess what sort of policy actions are in the offing and react to every move. The government is big and when it moves there are large waves in the marketplace.

Also, the synchronised nature of the global recession, and continuing problems in the financial system of several major economies, renders the outlook particularly uncertain in the eyes of investors. As a consequence, expectations are not well anchored and can be revised frequently, causing volatility in market prices.

Among all the noise, it is important to discern the signals that matter. Major policy errors have consequences for asset allocation and future investment performance. For example, it is now a common observation that government bonds may be experiencing a bubble - not just in the US. However, if one believes that we are descending into a severe deflationary environment, reminiscent of the 1930s, then these bonds are not extravagantly priced.

Such fears may be exaggerated. The likelihood of a depression-like scenario for the global economy is low. Governments around the world have taken massive action to forestall such an outcome. But, then again, this depends on the authorities refraining from committing another policy error, namely engaging in protectionism, competitive devaluation and eventual trade wars.

As for outperformance on a regional and country basis, those coming out of the recession with sounder private and public sector balance sheets are likely to be longer-term winners. But one must distinguish short and long run effects. Aggressive policy action by the US government may be rewarded by the markets, if the hope is that this will jumpstart the American economy faster than others. However, it may also dawn upon them that there may be other costs that could hobble growth for many years into the future.

The possibility of an eventual build-up of inflationary pressure may also favour those assets that offer some protection against the ravages of inflation. It is clear that some central banks, particularly the Fed, are deliberately trying to stoke inflationary fires. The intent is to lighten the burden carried by debtors and to restore some of the lost value in the real estate sector.

Lack of space precludes an examination of several other topics under the heading of volatility: algorithmic trading, tail events, black-swan occurrences and clustering. We will examine them in the future.

Iraj Pouyandeh is a strategist and senior portfolio manager at LOM Asset Management. He manages the LOM Global Equity Fund. For more information on LOM Asset Management please visit www.lomam.com