Tuesday, July 20, 2010

Sovereign defaults

In a post of what happens if things go really badly, I was surprised to see that the Asian economies that have a 5-year cumulative default probability (whatever this is supposed to be) of 10 percent or greater: Indonesia, Thailand, South Korea.

What I dislike about the graph is the following: Is there really a difference between 11 and 11.4 percent probability? Assuming that the model is estimated, where are the standard errors?

Another "feature" of these default models is the timing. When stuff happens we always wonder, why now? Why not last month? Why not yesterday? In many cases, it is the case that really nothing much has happened between the time economists say that these countries are in danger of defaulting and when it happens, e.g. Greece.

My guess is that there is some inattention or lack of focus by "people". You know the ones I'm talking about - they're constantly in crisis mode, switching their attention from one to another. When all is well, they're really not doing much. Then something is due e.g. a loan payment and they switch their attention to it and suddenly things aren't all that rosy and boom! Then when they're done fanning that one fire they decide to see what else they can torch and before you can say contagion, you're right smack in the middle of it.

I'd guess that if we looked at all the crises in history, very few have happened on holidays or during the summer vacations.

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