US bonds just keep on rising despite the US Fed again insisting this week that it doesn’t see inflation becoming a problem. A continuation in this vein spells bad news for emerging markets’ currencies and assets, with bonds likely to be worst hit by an erosion of their yield premiums in wha.
In 1979, Daniel Kahneman and Amos Tversky outlined prospect theory, which identifies economic behaviours that are inconsistent with rational decision making. Their theoretical take on probabilities and expectations could well prove relevant today in assessing the likelihood of historically low government bond yields being subject to potentially asymmetric outcomes.
One of the most significant insights from their theory is that people exhibit a significant aversion to losses when making choices between risky outcomes, no matter how small the stakes. Kahneman and Tversky found that a loss has about
two and a half times the “utility impact” of a gain of the same magnitude. In other words, people feel significantly worse about losses of a given magnitude than they feel good about a gain of similar magnitude.