Really quick, because (a) I am not a defaced Cameron poster so you ain’t reading and (b) I’m rushing home, and then have Jury Duty.

There is a lot of chatter about sovereign default risk.  Martin Wolf’s post on the Eurozone was a very bleak and true assessment of how the ex-ante risks of being in a currency union without flexibility can come true, ex post.  Brilliant – read it.

Simon Tilford of a similarly-named by different think tank wrote today about a possible Greek default. But I found fault with this:

Greece could default on its sovereign debt. The eurozone would then face a big problem. The financial markets would quickly turn their attention to other euro bloc economies with unsustainable fiscal positions and poor growth prospects.

This produces some weird image of financial markets like, I dunno, angry dogs that first savage one person, then another once they’ve mauled the first.  This is not exactly “efficient markets” – if they have a problem with Italy, why do they need to wait for Greece to fall over first?  The rational thing would be to anticipate the systemic fragilities in advance – such as the way some banks must hold a lot of Greek Debt and would be vulnerable after such an incident.  Otherwise there is a great free-money idea out there, somewhere.

George Magnus seems to make a similar anti-EMH mistke: he predicts that sovereign borrowing rates will rise soon.  But surely that presents the mother of all free-money schemes?  You could short  30-year UK government debt right now if you wanted, and just wait for it to fall by 10%.  It can’t be that simple.

Now, you know I am not a fully commited believer in EMH (see Scott Sumner’s discussion).  But be wary of anyone saying “this is how the financial markets are going to behave”.

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2 thoughts on “EMH and sovereign default risk

  1. The world in which EMH holds true is said to be peopled by Homo OEconomicus. No fossil or ethnological evidence exists for this mythic creature.

    S/he is the misper of all mispers yet dominates the social ‘sciences’.

    Fear is a social construction, as is bravery. Homo OEconomicus lives alone.

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