I’m deeply sympathetic to the extreme tragedy in Japan. The human loss and damage troubles me and makes focusing on markets unusually difficult. So far, I have determined that the pricing mechanism of free markets has failed miserably over the last week. Fat-tailed events in the most connected country in the world should lead to a fat-tailed market response. If we all knew what was going to happen this week last week, most of us would have lost money. Panic in markets? What panic? Russell 2000 down 1.5% for the week and S&P 500 down 2.5% does not even incorporate the news we know much less the extreme uncertainty left by the silent unknown and potential bad case. I have not seen markets pricing in the best case in all my market experience and extensive study.
Japanese CDS are at 117 bps and the JGB 10y offers 119 bps. 2 bps compensation for a potential loss of 2000 bps or more just does not make any sense.
The market will see a fat-tailed response in far more ways than the Yen and Nikkei. Markets experience fat-tailed distributions even without fat-tailed events, so I do not think this a grand assumption. The calamity is a fat-tailed events and will lead to far more significant consequences than we have experienced over the past couple of days.