Game Theory is a well known economic theory that won a noble prize in economics. However, on the surface is very simple and easy to understand so I’m going to explain it in a way any red blooded American man can understand.
Assume you and a buddy walk into a bar. At said bar, there are three girls; one babe
and two less attractive, but still hot enough girls:
In this scenario you and you buddy both try to bang the babe (Emily Ratajkowski). One of you may get lucky (very lucky) and bang Emily while the other gets nothing because he pissed off the two less attractive friends not giving them any attention. Or you could cock block each other and both get nothing.
However, if you both agree to not go after Emily and go after girls 2 and 3, you just may both get laid.
Voila, Game Theory. Two seperate parties working in cahoots to not necessarily serve themselves in the best possible way, but to ensure both parties get a desired outcome.
Its been 3 weeks since one of the biggest news events to hit the financial world since 2008 and the financial world seems to be in a peculiar position. Immediately following Britain’s referendum to leave the UK world markets plunged across the board. After the initial crash investors swooped in to take advantage of new found value in the market, and the market climbed to all time highs with the S&P 500 up to 2156.45.
However, a less publicized consequence to Brexit has been the effect on debt markets. After Brexit 10 year yields in government bonds, most notedly German, have been decreasing. This has put pressure on US bonds which now have its record low 10 year yield. This has created a huge divergence between stocks and bond yields with the stock market at an all time high, and the yield curve at an all time low. As indicated by the chart below (Forbes).
So what exactly does this mean, and why is it happening?
While related and often predictive of each other, the stock and bond market do not necessarily rely on each other. The stock market has increased in past weeks mainly due to how the world economy and US economy dealt with the short term Brexit panic insuring investor confidence. Confident investors=rising market. Bond yields are at all time lows as global panic pushed investors into what is considered the safest investment, US Treasury bonds. The increased demand in the bonds drives the yield down so it creates this simultaneous high stock market and low bond yield.
This has potential to be a good scenario for investors. If the ECB (European Central Bank) assures that it will sustain the bond market in Europe by buying European Bonds, this should affect the US by raising the yields here on bonds and further pushing the stock market forward as a result.