Tail Risks Lurk In The Shadows. Fiscal Cliff Is Out In The Open
Sober Look | Nov 08, 2012 04:44AM ET
Merrill conducts a periodic survey of US institutional money managers. One area the survey focuses on is a set of questions on the so-called "tail risks," the less probable but potentially devastating events that negatively impact financial asset valuations. Here are the survey results from September and October of this year.
The US fiscal cliff is clearly on people's minds and is quickly becoming the dominant concern in the financial community. If this survey were conducted today, the percentage of participants who would view the upcoming budget cuts and tax increases as the main risk to their portfolios would increase sharply. In fact, based on Google Trends, the public's concerns about the US fiscal cliff have spiked recently.
But once certain risks become this widely "respected," they can no longer be called "tail risks." In fact as we saw in today's equity markets, these risks are already being priced into the markets.
Tail risks are usually those events that are not fully priced, risks that are ignored, sometimes leading to formations of asset bubbles. What would be an example of such a risk these days? One potential candidate may be some of the US bond markets, for example credit (see post ), possibly even earlier. Instead one should look at the less probable events that most investors are now simply ignoring.
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