Friday, March 13, 2009

Safe versus risky investment

I previously blogged about a new project of mine that looks at the inequality effects of financial crises. It's premised on the fact that crises arise from financial risk taking. Recent research has found that countries that engage in some risk, rather than avoiding risk entirely, experience more crises, but also, even given the crises, enjoy greater overall growth. My work is focused on answering the question who benefits? Not surprisingly, I find its the rich that benefit from the risk, with the poor losing out on all growth.

The finding that engaging in risk is overall good for an economy comes from Ranciere et al. and can be seen by comparing the growth trends of India, who avoids most risk, and Thailand, who has taken on a lot of risk in its economy:

In the end, despite a very serious economic collapse in 1997, Thailand is ahead.

The recent financial crisis gives a great view of how this finding can be difficult to measure. Bloomburg has a great graph of bond (safe) versus stock market (risky) returns:

Notice that this graph looks a lot like the GDP comparison between India and Thailand, before 2008. One might have concluded that risk was a good idea a year ago, but not now. Of course, who knows what this will look like in 10 years ...

(hat tip to Infectious Greed)

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