Tuesday, 26 June 2012

Grexit Risk; The Day After

In the fallout after May 6, Elections in Greece and Government formation stalemate, SYRIZA posed a serious tail event risk for an uncontrolled “Grexit” (Greece exit from the Eurozone). Thus, the recent Election result of June 17th, has removed that risk.
However, even before the last Election, a possible weak Government implied a far more serious tail-event risk in the medium term (3-6 months ahead) compared to the imminent risk posed by SYRIZA's proclamations.
Probabilities before June 17th:                                                                          Pi      Pii       
a)      ND/PASOK form a strong pro-Europe Government                           45%   25%
b)      SYRIZA wins the Election and orchestrates its plan                         40%   75%
c)      A weak government is formed and a third Election is required        15%   90%
Pi = probability of outcome, Pii = probability of Grexit
Tail-Event Risk before = (45%x25%) + (40%x75%) + (15%x90%) = 54.75%
After the Election and although the result was in line with scenario (a) above, the three parties of the pro-European front failed to form a strong Government. PASOK & Democratic Left (DEMAR) support the new Samara's Government but don’t participate in it, not in any meaningful manner anyway. That is perceived by many analysts as a weak support that may break at any time under either pressure from the TROIKA or from the populist opposition party’s rhetoric.
Thus, scenario (c) is back in the play (see scenario 2 hereafter).
New probabilities after June 17th:                                                                     Pi      Pii       
1)      The new Government gains momentum and support                       50%   25% (a)
2)      The weak government formed falls in 3-6months                            50%   90% (c)
Pi = probability of outcome, Pii = probability of Grexit
Tail-Event Risk after = (50%x25%) + (50%x90%) = 57.5%
(And this can become even worse if Pi1 is 40% and Pi2 is 60%, thus the new probability of a Tail-Event Risk rises to 64%)

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