Markets’ Rational Complacency
A century ago, financial markets priced in a very low probability that a major conflict would occur, blissfully ignoring the risks that led to World War I until late in the summer of 1914. Back then, markets were poor at correctly pricing low-probability, high-impact tail risks; they still are.
NEW YORK – An increasingly obvious paradox has emerged in global financial markets this year. Though geopolitical risks – the Russia-Ukraine conflict, the rise of the Islamic State and growing turmoil across the Middle East, China’s territorial disputes with its neighbors, and now mass protests in Hong Kong and the risk of a crackdown – have multiplied, markets have remained buoyant, if not downright bubbly.
Indeed, oil prices have been falling, not rising. Global stock markets have, overall, reached new highs. And credit markets show low spreads, while long-term bond yields have fallen in most advanced economies.
Yes, financial markets in troubled countries – for example, Russia’s currency, equity, and bond markets – have been negatively affected. But the more generalized contagion to global financial markets that geopolitical tensions typically engender has failed to materialize.