The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Friday, April 27, 2007

The Economist on Credit Derivatives and Market Liquidity

The Economist magazine has a couple of interesting (and related articles) on finance and investing.

In its special report, Credit derivatives: At the risky end of finance (April 19, 2007) , The Economist closely examines both the benefits and potential risks of credit derivatives. The pros of credit derivatives include the possibility that they make investing and trading in the bond markets more palatible. The cons are that they might be a ticking financial time bomb -- a "financial weapon of mass destruction" in Warren Buffett's phraseology -- that are vulnerable to shifting market conditions (e.g., a major increase in interest rates).

In this week's issue, Liquidity: Deal or no deal -- A new measure of market health (April 26, 2007), The Economist highlights how the Bank of England is trying to clear up the muddle about how to measure market liquidity. The Bank of England's measures (they have three) of liquidity is based on the "ease of buying and selling financial assets." According to its measures, the markets are flush with liquidity. Why? The article offers many explanations (hedge funds, financial innovations -- like credit derivatives, etc.), but it also points out that this surge of liquidity is a fickle thing. I.e., there will be more liquidity so long as investors are confident; when confidence wanes, liquidity probably will drop as well.

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