The Decline in European Risk Premia is Unsustainable

By Walter Kurtz, Sober Look

Investors continue to shift attention from Europe to the US, as the fiscal cliff concerns are now center-stage (see discussion). The equity implied volatility risk premium of the Euro Stoxx 50 (SX5E) to that of the S&P500 (SPX) has come off sharply recently (see figure 1).

This is somewhat surprising because Europe is likely to be impacted by the US fiscal cliff economic shock as much as the US, possibly more. The EU member nations’ companies are far more vulnerable to a further global slowdown (even if it originates in the US) than the US corporate sector.

CS: – We think that a fiscal cliff-induced growth shock, while negative for the US economy, could prove even worse for Europe. The current macroeconomic picture is one of cyclical stabilization appearing to be under way in the US, compared with a still fragile euro area, where recent data releases have revealed further weakness for the core [see discussion],making substantial deterioration highly likely in the event that extra stress is added to the mix by an external shock.

Indeed, CS expects this ratio to move back up, as the Europe risk premium returns.

(Figure 1)

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Sober Look

Sober Look

Sober Look was founded by Walter Kurtz, a New York based hedge fund manager and credit markets specialist.

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