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COMMENTARY: Risk and uncertainty
Tuesday's US election results were a shock felt around the world – but, after the first few hours of sell-offs driven by uncertainty, the impact on financial markets was surprisingly muted. By the end of the day on which the election result was announced, investors shifted from risk-off to risk-on trades.
The biggest immediate lesson seems to be that political risk is just as tricky to predict as market or credit risk. For all the ingenuity that went into various poll aggregators and election forecasts, few seemed to have included consideration of model risk. No doubt polling autopsies over coming weeks and months will reveal this year's specific failings, but blindly trusting revamped versions of political prediction models next year (as we run up to French and German elections) would be folly.
And there's also the point that the end of the election doesn't mean the end of uncertainty. No US president in history has taken office with so little experience in the business of government – previous presidents have generally been state governors, senators, cabinet secretaries or vice-presidents, and their records have provided some insight into how they would govern once elected. Even Dwight Eisenhower, though never elected to office prior to winning the presidential race in 1952, had served as supreme allied commander Europe.
Trump, too, has shown over the past 18 months a remarkable ability to change his policy proposals to suit his audience (the Great Wall of Mexico has been figuratively built and demolished several times during the course of his campaign). Despite the president elect's talk of dismantling it, many expect the Dodd-Frank Act to survive – probably in a milder form. Trump is likely to follow his advisers here, and they cover a wide range of the political spectrum.
In short, political risk (who will win the election) was poorly modelled – and political uncertainty (what is going to happen next) is now enormous. Time for risk management and compliance businesses to start thinking very hard about what to do next.
STAT OF THE WEEK
QUOTE OF THE WEEK
"The Basel Committee's current mandate to achieve capital neutrality requires adjustments unrelated to safety and soundness – and to what end? It is not designed to capture risk in the assets subject to weighting, but rather to ensure capital requirements for the industry remain unchanged. This proposal does nothing to improve the stability of the global financial system, it only weakens it, and it does not promote long-term growth" – Thomas Hoenig, FDIC vice-chair
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