Market Pricing Greece

One of my students asked me why we should worry about a Greek default or exit from the euro when the markets can already factor those risks into the price of any assets likely to be affected in the markets. This is the same question that Gillian Tett highlights in her column in the FT last Friday. Tett’s answer is that there are always institutional quirks in the markets that are hard to factor into different prices. That answer should send investors – and their lawyers – to look through the fine print of marketable assets to find arbitrage opportunities that have not yet been exploited.

They shouldn’t bother. They may well find something worth exploiting but that won’t make it easier to price in the risks around Greece. The reason market participants fail to price such risks efficiently has less to do with the completeness of their models than with the fact that many if not most of them are going to switch from one set of models to another in the event of a Greek default. It is this model switching – and not the discovery of new information – that will roil the markets. Moreover, no-one can predict just how big of an impact this model switching will have on prices. I suspect it will be large.

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The Politics of Conviction and Conviction as Policy

The spring meetings of the International Monetary Fund (IMF) and the World Bank offer a great opportunity to listen to policymakers explain their views on the evolution of the world economy. For those of us interested in Europe, the focus at this year’s meetings was on the double feature of German Finance Minister Wolfgang Schäuble and Greek Finance Minister Yanis Varoufakis at Brookings last Thursday. It was a good match-up that offered few fireworks. Both sounded reasonable without departing from their basic positions. Schäuble wants Greece to honour its commitments; Varoufakis wants Greece’s creditors to embrace of new set of priorities for reforms. Both also claimed to speak in the interests of Europe writ large and neither accepted the possibility that interest could coincide with Greece leaving the euro. Hence it would be easy to come away with the impression that whatever the status of the negotiations things are unlikely to fall apart over Greece. And I suspect that was the goal — to convince investors to view the latest setbacks in negotiations as a reflection of ‘normal’ European politics.

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What Kind of Europe?

According to analysts at Macropolis, the Greek banking system lost € 24.6 billion in deposits between December 2014 and the end of February 2015. The money has tended to ebb and flow in line with the tension in the talks between the Greek government and its creditors. On balance, however, the flow has exceeded the ebb and so the Greek banking system is now weaker on the liability side than it has been since 2012. Such a trend cannot continue indefinitely. And, as one-time chairman of the Council of Economic Advisors Herbert Stein once quipped, if something cannot go on forever, it will stop.

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