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Sunday, October 9, 2011

Betting against France

James Mackinstosh from the Financial Times has a great article on a strategy many hedge funds seem to be taking.

Long Italy - short France... and not because Italy is better shape... No way... The point is simply the spreads

According to the spreads (against the Deutsche Bund) here is how closely they stack (in basis points)

Italy 350

France 70

Is Italy really 5 times riskier than France?
So something is got to give. F
a) Things get bad, ECB intervenes to stop a run on Italy, France gets infected increasing its spread to level it to that of Italy, or
b) Things get better, Italy's spread goes down to match France's
There is always c) ECB dumps the PIIGS (Italy included) and let everybody fend for him/herself...

Just for the fun here is where the PIGS stand

Portugal 995

Ireland 575

Greece 2,227

Spain 298

And Belgium, courtesy of Dexia 195

To me, it seems like these spreads are priced as if there was no correlation between debtors, just as the CDOs were before 2008. The problem is that given that one country goes belly up, the probability of the next one going under is much higher.

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