Thursday, October 31, 2013

Apropos of Nothing but my Own Interest: Sticky Risk

Economists are already familiar with the idea of sticky wages and prices, both of which adjust slowly to changes in the market environment. 
For instance, home owners resist cutting their asking price in the face of a slump, preferring to withdraw and not trade. Existing wages tend not to be cut, instead eroding via inflation while unemployment remains high. 
With sticky risk, its the assessment of risk that displays stickiness: individuals refuse to change their view of danger until the evidence becomes overwhelming. 
There is sound logic to acting in this way. In 2011, when the simmering European crisis and a US debt downgrade produced three months with wild swings in markets, the best response was simply to do nothing and wait it out. 
Like a ball sat in a bowl, a shove will send it spinning back and forth, but eventually gravity restores the ball to equilibrium.
We think this helps to explain the current environment of what seems to be widespread but low-conviction optimism. To overgeneralise, the attitude is that while the central bankers are keeping interest rates down, take yield where you can find it. 

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