A Real-Time Risk Premium Increase

The DJIA, S&P 500 and NASDAQ from 2/19/09 to 2/23/09

Market indices dropped by an average of ~3.5% today, seeing 1997 lows.

From today’s Wall Street Journal, the drops are because of uncertainty on how Washington will deal with US banks, and how Europe will cope with the crisis. Currencies didn’t fare too well either, with lots of selling overall.

The euro fell more than three U.S. cents to $1.2697 by late afternoon from a nearly two-week high of $1.2992 overnight, with a decline in U.S. stocks and crude-oil futures on renewed investor risk aversion.

Traders sold the common currency, along with other riskier assets, on uncertainty over Washington’s plans for U.S. banks, as well as cautious remarks from European Central Bank President Jean-Claude Trichet.

Mr. Trichet warned Monday that the euro zone’s financial system is facing challenging times as financial markets and the real economy are dragged in a downward spiral. He said financing in the euro zone is dwindling. [link]

The table below shows the value of various currencies per one dollar. Smaller numbers relative  to the past mean a dollar depreciation and are shown in red. Larger numbers relative to the past mean an appreciation. Lots of bloodshed today.

Currency values in dollar terms on 2/23/09

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2 comments for “A Real-Time Risk Premium Increase

  1. Patrick Kim
    March 3, 2009 at 12:54 pm

    The appre/depreciation table above,,is this related to “investment” in USA, having capital coming from either other countries or within USA. Like, since the uncertainty rises, people do not invest more to USA, resulting dollar depreciate compared to other currencies? (since dollar depreciates from more of countries)

  2. Aaron Covarruvias
    March 5, 2009 at 12:16 pm

    In response to your question:

    I agree. Due to the current uncertain state of the economy, foreign investors are hesitant to invest in the U.S. (and other countries). The foreign exchange market shows us this as skeptical foreign investors demand less U.S$ in the foreign exchange market (an inward shift of the demand curve for U.S$). This results in a lower exchange rate (the U.S.$ is worth less in terms of other currency) and a consequent surplus of U.S$ on the market (caused by the demand shift), both of which yield a depreciated value of the U.S.$. So I would say that yes, uncertainty–>decreased investment in U.S–>depreciation of U.S.$.

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