Will Russia default, and if so, will it lead to financial crisis?
post by sanxiyn · 2022-03-09T06:34:00.567Z · LW · GW · 4 commentsThis is a question post.
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Answers 2 arunto -1 ChristianKl None 4 comments
I live in South Korea. Apart from threat of nuclear war, which seems low so far, the primary impact of Ukraine war seems to be potential default of Russia and its possibility to lead to financial crisis.
"Will Russia default?" is a rare question with a liquid real money prediction market, called CDS(credit default swap). Bloomberg claims the market implies 80% chance of default. Sadly I don't know how to do that computation myself, so please tell us if you can explain it step by step.
Russia defaulted in 1998. As I understand, it led to collapse of LTCM and almost led to financial crisis, akin to bankruptcy of Lehman Brothers and Global Financial Crisis. In 1998, crisis was averted by bailout organized by Federal Reserve, but we may not be as lucky this time, as we weren't in 2008. I hope financial industry advanced in terms of risk management since 1998 and 2008, but in fact don't know whether it did. If you know, please tell us.
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Sadly I don't know how to do that computation myself, so please tell us if you can explain it step by step.
Here is an IMF working paper explaining the process (there is not one single formula for that, so we don't know exactly how Bloomberg has calculated it). Market-Based Estimation of Default Probabilities and its Application to Financial Market Surveillance
Basically, you need at least two pieces of information:
- The price spread of the CDS
- The expected recovery rate (RR) - how much money will the creditors get back (which in most cases is more than zero).
However, in the case of Russia it seems to be a bit complicated:
Dislocation in Russian debt prices suggests CDS won't work
(The article is a few days old; I don't know if the current prices still show this problem).
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I would be very surprised if there will not be some players in the financial markets killed by a Russian default. There are always people who are "picking up nickels in front of a steam roller". But I have no prediction whether there will be one or more systemically relevant institutions being hit by this.
LTCM did worse than average risk modeling because they assumed a bunch of assumptions about risks being normal distributed and thus thought that their investments were less risky than traders would commonly assume. See Nasim Taleb (I think the Black Swan) for more details.
The fact that the market currently implies an 80% chance of default suggests that default is well priced in by the risk models.
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comment by jbash · 2022-03-09T15:10:26.744Z · LW(p) · GW(p)
I'm a lot more worried about gas, oil and wheat than about abstract financial instruments...
Replies from: ChristianKl, sanxiyn↑ comment by ChristianKl · 2022-03-09T19:47:34.638Z · LW(p) · GW(p)
At the moment Nickel seems to be the biggest problem. The price is a hockey stick at the moment.
Replies from: sanxiyn