Guns are dangerous so are pools, but which one is more dangerous? Steve Levitt a Professor from the University of Chicago analyzed this question through economic analysis. His results overwhelmingly supported the conclusion that pools killed 1000 times more children; yet pool control laws are not on the agenda for Congress. In short expectations are every thing in terms of risk. A gun is perceived to be dangerous and many are terrified by their existence. Pools are more dangerous but no one runs for cover from a pool. Rationale decisions are a major part of risk analysis apart from justifying banker’s salaries; it leads investors to prudent investments. In order to judge whether the risk premium associated with an investment is worth the reward; models are employed. The list of models is endless some of the simple familiar models are CAPM, MAR, VAR. Almost all the models are constructed from data that uses correlations to construct portfolios with low variance returns. Recently these models have failed to measure risk and the financial sector is suffering because of this failure.
Risk applied to the currency market can justify the Euro’s appreciation. Central banks have decreased their exposure to the dollar by diversifying to the Euro and other major currencies. This is theoretically in their best interest because by reducing their exposure to the dollar they are lowering the variance of their portfolio. However by reducing their exposure they have flooded the market with dollars, thus a depreciation of the dollar has been occurring for the past seven years. The question remains when will the diversification stop, and whether countries will start buying the dollar again. We are no where close to the monthly simple moving average of the EURUSD, which suggests that we have a long way to go until equilibrium is reached. I am not suggesting that a reversal is afoot, however I am hinting that the depreciation of the dollar has reached a peak, and the resistance at 1.60 may not been broken in the near term. The risk of an undervalued dollar is beginning to outweigh the risk associated with dollar heavy portfolio. Inflation has risen to alarming rates and the correlation between a 33 percent depreciation of the dollar and the rise in commodities is evident. By acknowledging that risk influences Central Bank decisions a trader stands to gain. The market for the EURUSD is range bound until it crosses 1.53, if it does then sell and hold on for the ride.
Risk applied to the currency market can justify the Euro’s appreciation. Central banks have decreased their exposure to the dollar by diversifying to the Euro and other major currencies. This is theoretically in their best interest because by reducing their exposure to the dollar they are lowering the variance of their portfolio. However by reducing their exposure they have flooded the market with dollars, thus a depreciation of the dollar has been occurring for the past seven years. The question remains when will the diversification stop, and whether countries will start buying the dollar again. We are no where close to the monthly simple moving average of the EURUSD, which suggests that we have a long way to go until equilibrium is reached. I am not suggesting that a reversal is afoot, however I am hinting that the depreciation of the dollar has reached a peak, and the resistance at 1.60 may not been broken in the near term. The risk of an undervalued dollar is beginning to outweigh the risk associated with dollar heavy portfolio. Inflation has risen to alarming rates and the correlation between a 33 percent depreciation of the dollar and the rise in commodities is evident. By acknowledging that risk influences Central Bank decisions a trader stands to gain. The market for the EURUSD is range bound until it crosses 1.53, if it does then sell and hold on for the ride.
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