It is the cause and consequence of Irrational Exuberance:
"There is little doubt that, with the breakup of the Soviet Union and the integration of
China and India into the global trading market, more of the world's productive capacity
is being tapped to satisfy global demands for goods and services.
Concurrently, greater integration of financial markets has meant that a larger share of the
world's pool of savings is being deployed in cross-border financing of investment.
The favorable inflation performance across a broad range of countries resulting from
enlarged global goods, services and financial capacity has doubtless contributed to expectations of
lower inflation in the years ahead and lower inflation risk premiums.
But none of this is new and hence it is difficult to attribute the long-term interest rate declines
of the last nine months to glacially increasing globalization.
For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.
Bond price movements may be a short-term aberration,
but it will be some time before we are able to better judge the forces underlying recent experience."
Chairman Alan Greenspan
Federal Reserve Board's Semi-Annual Monetary Policy Report to the Congress.
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate.
February 16tn, 2005
Discontinuity:
The inverted yield curve is an unstable equilibrium because the long-term rates are undervalued.
It runs against the optimization of risk/return of portfolios and the self interest of financial institutions:.
"I made a mistake in presuming that the self-interests of organizations,
specifically banks and others, were such as that they were best
capable of protecting their own shareholders and their equity in the firms."
Chairman Alan Greenspan
Testimony at the House Oversight and Government Reform Committee.
Answering a Question from Representative Henry A. Waxman.
October 23rd, 2008.
A discontinuous twist of the yield curve changes in a chaotic way the Market value of long-term assets.
"Our day-by-day experiences with the effectiveness of flexible markets as they adjust to, and correct,
imbalances can readily lead us to the conclusion that once markets are purged of rigidities,
macroeconomic disturbances will become an historical relic.
However, the penchant of humans for quirky, often irrational,
 behavior gets in the way of this conclusion.
A discontinuity in valuation judgment, often the cause or consequence of a building and bursting of a bubble,
can occasionally destabilize even the most liquid and flexible of markets.
I do not have much to add on this issue except to reiterate our need to better understand it."
Chairman Alan Greenspan
Globalization and Innovation.
At the Conference on Bank Structure and Competition,
Sponsored by the Federal Reserve Bank of Chicago, Chicago, Illinois.
(via satellite)
May 6th, 2004
Low Risk Premia:
This inverted yield curve is due to a clear underpricing of the risk premia.
A "random shock" will cause an onset of investor caution, increasing these risk premia to they fair value.
It will normalize discontinuously the yield curve.
It will create a chaotic behavior of credit Markets.
"There is little doubt that, with the breakup of the Soviet Union and the integration of
China and India into the global trading market, more of the world's productive capacity
is being tapped to satisfy global demands for goods and services.
Concurrently, greater integration of financial markets has meant that a larger share of the
world's pool of savings is being deployed in cross-border financing of investment.
The favorable inflation performance across a broad range of countries resulting from
enlarged global goods, services and financial capacity has doubtless contributed to expectations of
lower inflation in the years ahead and lower inflation risk premiums.
But none of this is new and hence it is difficult to attribute the long-term interest rate declines
of the last nine months to glacially increasing globalization.
For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.
Bond price movements may be a short-term aberration,
but it will be some time before we are able to better judge the forces underlying recent experience."
Chairman Alan Greenspan
Federal Reserve Board's Semi-Annual Monetary Policy Report to the Congress.
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate.
February 16tn, 2005
Discontinuity:
It runs against the optimization of risk/return of portfolios and the self interest of financial institutions:.
"I made a mistake in presuming that the self-interests of organizations,
specifically banks and others, were such as that they were best
capable of protecting their own shareholders and their equity in the firms."
Chairman Alan Greenspan
Testimony at the House Oversight and Government Reform Committee.
Answering a Question from Representative Henry A. Waxman.
October 23rd, 2008.
A discontinuous twist of the yield curve changes in a chaotic way the Market value of long-term assets.
"Our day-by-day experiences with the effectiveness of flexible markets as they adjust to, and correct,
imbalances can readily lead us to the conclusion that once markets are purged of rigidities,
macroeconomic disturbances will become an historical relic.
However, the penchant of humans for quirky, often irrational,
 behavior gets in the way of this conclusion.
A discontinuity in valuation judgment, often the cause or consequence of a building and bursting of a bubble,
can occasionally destabilize even the most liquid and flexible of markets.
I do not have much to add on this issue except to reiterate our need to better understand it."
Chairman Alan Greenspan
Globalization and Innovation.
At the Conference on Bank Structure and Competition,
Sponsored by the Federal Reserve Bank of Chicago, Chicago, Illinois.
(via satellite)
May 6th, 2004
Low Risk Premia:
This inverted yield curve is due to a clear underpricing of the risk premia.
A "random shock" will cause an onset of investor caution, increasing these risk premia to they fair value.
It will normalize discontinuously the yield curve.
It will create a chaotic behavior of credit Markets.
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