The implied probability of a stock market crash seems wrong

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One more from that James Montier GMO letter I linked to yesterday. And I totally agree with this point…

Markets appear to be governed by complacency at the current juncture. Indeed, looking at the options market, it is possible to imply the expected probability of a significant decline in asset prices. According to the Minneapolis Federal Reserve, the probability of a 25% or greater decline in US equity prices occurring over the next 12 months implied in the options market is only around 10% (see Exhibit 12).

Now we have no idea what the true likelihood of such an event is, but when faced with the third most expensive US market in history, we would suggest that 10% seems very low.

The Reformed Broker

Josh here – I’m not here to say “it should be 30% or 50%” or whatever. I would just say that 10% seems wrong.

Hope I’m wrong about that. But if I’m right, I’m prepared.

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