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Resolving the Paradox: Decreased Business Cycle Risk vs. Increased Financial Cycle Risk

This article explores the paradox of decreased business cycle risk and increased financial cycle risk, offering a resolution based on first principles. It analyzes key macro variables, growth rates, and the changing composition of equity market risk. It also discusses the reasons for greater endogenous risk and the evolution of market belief structures.

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Resolving the Paradox: Decreased Business Cycle Risk vs. Increased Financial Cycle Risk

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  1. Horace W. Brock, Ph.D. President Strategic Economic Decisions, Inc. WWW. SEDINC.com

  2. Decreased Business Cycle Risk vs. Increased Financial Cycle Risk: A Resolution of this Paradox from First Principles

  3. PERCENT DROP DURING 5 RECESSIONS OF KEY US MACRO VARIABLES

  4. STANDARD DEVIATIONS – US GROWTH RATES Source: BEA, SED

  5. STANDARD DEVIATIONS OF THE S&P 500 (Nominal) GROWTH RATES Source: Standard & Poor’s, BLS, SED

  6. STANDARD DEVIATIONS – EUROPEAN UNION GROWTH RATES

  7. STANDARD DEVIATIONS OF THE S & P 500 (Nominal) GROWTH RATES

  8. THE CHANGING COMPOSITION OF EQUITY MARKET RISK

  9. INCREASED ENDOGENOUS RISK IN GLOBAL EQUITY MARKETS Source: SED

  10. Detailed Reasons for Greater Endogenous Risk(1950-2000) • Increased “pricing-model uncertainty” • Benchmarking of performance • New information on market expectations (first call) • New ability to “know” and to “react” to the news • Collapse in cost of trading

  11. Long-Term Endogenous Risk – Bull and Bear Market Regimes –

  12. REAL RETURNS AND NET WORTH GROWTH – The Three Most Recent Regimes – REAL D-J IND. INDEX REAL HOUSEHOLD NET WORTH REAL HOUSEHOLD REAL ESTATE ASSETS REAL BOND INDEX

  13. STOCK MARKET VERSUS BUSINESS CYCLES

  14. EVOLUTION OF MARKET BELIEF STRUCTURES Source: SED

  15. BEFORE AFTER

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