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Nothing Surprising About the Eurozone Crisis

There should be nothing surprising about the Eurozone crisis. Below are three charts:

  1. Spanish debt payment obligations, excluding anything below a 1 billion Euros (to make the chart cleaner). 20,000 means 20 billion Euros
  2. Italian debt payments obligations, also excluding anything below 1 billion Euros
  3. Interest rates at various maturities for Spain (top line), Italy (next), and Germany (bottom). Vertical axis is interest rate, horizontal maturity.



Looking at these images you can see exactly the amount of debt that each country needs each month. They can get it from the debt market or some other lender.

In other words there should be nothing “surprising” about the Euro crisis. Every week we know exactly how much financing these countries will need.

Each month Spain and Italy need to sell new debt to investors to payback existing bonds and make interest payments.

  • Interest rates are too high and rising meaning that these countries sooner or later will not be able to sell debt and/or pay interest
  • Their banking systems hold a lot of this debt on their balance sheets, and as interest rates rise the market value of the debt falls and the banks lose more and more money. Even if they don’t have to mark the debt to market they have less ability to finance themselves and/or make loans. This means that businesses and individuals can’t get a loan.
  • As the banks look worse and worse, depositors withdraw money and move it to banks in Germany further weakening the domestic banks in Spain and Italy.

Unless you believe something is going to fundamentally change with the ability of Spain and Italy to finance themselves, then the unfolding of the Euro crisis and the “shocks” that are to come should not be a surprise to you.

PS – France is next.

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Problems with CAPM

The capital asset pricing model (CAPM)  assumes that…

… investors agree on the return, risk and correlations of all assets and invest in all assets accordingly

Investors clearly disagree frequently on all of these, and many investors have limits on what asset classes they can invest in.


… perfect capital markets exist: there are no restrictions on borrowing and lending

Many investors face leverage constraints, forcing them to overweight risky assets in search for higher returns.


… all investors have the same time horizon

Investors with different time horizons consider different assets “risk-free”

Some investors have real vs. nominal liabilities

Different investors will choose different portfolios to leverage or de-leverage


… investors can securitize and trade all wealth

The majority of the world’s wealth is not securitized (human capital, residential real estate, etc.)

Investors owning different non-tradable assets could chose different optimal portfolios of tradable assets


… all investors are mean-variance optimizers

Many are not