The True Sources of Risk

But how does one cover regulatory risk? Delay investment until the political climate is more favorable? Move it offshore? Spend money on lobbyists?

Is there a straightforward way to estimate the impact of regulatory risk avoidance on the overall economy?

Chris,

Robert Higgs has written about this in "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War". For a readable overview of the economic approach to this type of problem, try Robert Pindyck's paper "Irreversibility, Uncertainty and Investment" (Journal of Economic Literature, 1991). The basic idea of the Pindyck paper is that, other things being equal, an investment is more valuable if you can delay committing to it than it is if you can't delay. Higgs applies this idea to the uncertain political climate of the New Deal, when business owners in various industries had reason to think they might be nationalized, or at least become subject to much more stringent regulation, in the near future.

"Credit risk is best hedged through diversification across uncorrelated credits."

Except that, as has been demonstrated a few times now, when it matters most, correlation of previously uncorrelated credits quickly trend towards 1. Just ask the Nobel Laureates of former LTCM.

W.M.: He does say best hedged, not perfectly hedged.

Blakeney,

Thanks for taking the time to provide these references. I don't currently have access to an academic library so the Pindyck paper will be hard to get, but I've downloaded the Higgs article and look forward to reading it.