The One-in-a-thousand-day Problem

Economic

Summary:

This column argues that such drastic behavioural changes render statistical analyses based on normal times ineffective.

In times of extreme stress, banks instinctively prioritise self-preservation to weather the storm. Whereas this is understandable from their perspective, it leads to perhaps the most significant harm caused by financial crises.

Milton Friedman's controversial criterion states that a business's objective is to make money for its owners (see Kotz 2022). When applied by a bank CEO, this principle manifests in two distinct behavioural regimes.

Most of the time – perhaps 999 days in a thousand – banks focus on maximising profit through regular borrowing and lending activities.

However, on that rare one day in a thousand, when a major upheaval strikes and a crisis unfolds, short-term profit takes a backseat to survival. Banks halt the provision of liquidity and start hoarding it, triggering runs, fire sales, and a denial of credit to the real economy. This is usually the main economic damage of crises. It is difficult to predict or prevent – and impossible to regulate – because it arises from self-preservation.

These two vastly different behavioural regimes frustrate investors and regulators, not least because statistical models based on normal times fail to capture them.

The one-in-a-thousand-day problem

The buildup to a crisis and the recovery afterwards are prolonged processes that can span years or even decades. But the actual crisis erupts suddenly, catching almost everyone off guard. It is as if we go to bed one night and wake up the next morning to find ourselves in a crisis.

Fortunately, crises are rare. According to Laeven and Valencia's (2018) financial crises database, the typical OECD country experiences a systemic crisis once every 43 years. Given that the high-intensity phase of a crisis is relatively short, it is reasonable to say that a country is not in an acute crisis 999 out of a thousand days, but in crisis on that one remaining day.

The intense phase of a crisis is driven by banks striving to survive. Profit becomes irrelevant because they are willing to incur significant losses if it means securing their future. Critical decisions are made for entirely different reasons than usual – and often not by the usual people.

Survival hinges on having as much liquidity as possible. Banks minimise liquidity outflows and convert their liquidity into the safest assets available – historically gold; today, central bank reserves. When investors ‘went on strike’ in August 2007, they were motivated by survival.

This drive for self-preservation leads to fire sales and runs. Entities dependent on ample liquidity face hardship or even collapse, while the real economy suffers as credit lines are cancelled and banks refuse to lend. These outcomes constitute the main damage from crises and explain why central banks inject liquidity during such times.

Collectively, this indicates two distinct states: the usual 999 days when banks maximise profit, and that critical last day when they focus on survival. Roy's (1952) criterion aptly describes this behaviour – maximising profit while ensuring they do not go bankrupt. Thus, these two behavioural regimes are a direct consequence of aiming to maximise shareholder value.

Speed is essential

The shift from pursuing short-term profits to survival happens almost instantaneously. Once a bank decides it needs to weather a storm, acting quickly is crucial. The first bank to withdraw liquidity from the system stands the best chance of survival. Those who hesitate will suffer, and even fail.

This was evident when the Hong Kong family office Archegos Capital Management could not meet margin calls. Two of its prime brokers – Morgan Stanley and Goldman Sachs – acted almost immediately and mostly avoided losses. The other two – Nomura (which lost about $2 billion) and Credit Suisse (which lost about $5.5 billion) – hesitated, held lengthy meetings, and hoped for the best.

Implications for risk measurement

The one-in-a-thousand-day problem signifies a complete structural break in the financial system's stochastic processes because the 999-day regime differs fundamentally from the crisis regime.

Each 999-day regime also differs from others. Crises occur when risks are ignored and accumulate to a critical point. Once a crisis happens, that particular risk will not be overlooked again, and new hedging constraints will alter how prices evolve. This means we have a limited ability to predict price movements after a crisis.

Consequently, models based solely on the 999 normal days – an almost unavoidable practice – cannot forecast the likelihood of a crisis or its developments. Attempting to do so leads to what I have termed ‘model hallucination’ (Danielsson 2024).

This also explains why market risk techniques such as value-at-risk (VaR) and expected shortfall (ES), which focus on relatively frequent events (for VaR, one in a hundred days; for ES, one in forty days), are inherently uninformative about crises.

After the 2008 crisis, I organised an event with senior decision makers from that period. Tellingly, one of them remarked: "We used the models until we didn't".

Policy consequences

The one-in-a-thousand-day problem leads to significant misunderstandings about crises.

Excessive leverage and reliance on ample liquidity are the underlying causes of crises. But the immediate crisis trigger and the ensuing damage result from financial institutions simply trying to survive.

Therefore, when analysing crises, we must consider both factors: leverage and liquidity as the fundamental causes, and self-preservation as the immediate cause, which influences the likelihood and severity of a crisis.

We can regulate leverage and liquidity through macroprudential measures. However, we cannot regulate self-preservation. Banks’ behaviour during a crisis is not misconduct or excessive risk-taking – it is the instinct to survive.

In fact, financial regulations can inadvertently exacerbate the one-in-a-thousand-day problem.

Imagine all financial institutions prudently adhere to regulatory demands. Regulators increasingly instruct them on how to measure and respond to risk. When an external shock occurs – such as a virus outbreak or war – all these prudent institutions perceive and react to the risk similarly because they are following the same instructions from the authorities. The result is collective selling in a declining market and uncontrollable fire sales. These prudent banks are not permitted to put a floor under the market and halt the fire sales. Only central bank liquidity injections do so.

This is the fallacy of composition in financial regulations: making all institutions prudent can actually increase the likelihood and severity of crises.

The impact of artificial intelligence

The growing use of artificial intelligence (AI) exacerbates the one-in-a-thousand-day problem (Danielsson and Uthemann 2024).

In banks, one of the primary users of AI and advanced computing is the treasury function – the division that manages liquidity. When the treasury AI detects rising uncertainties, it swiftly decides whether to profit by supplying liquidity and stabilising the market, or to withdraw liquidity, which might trigger systemic stress.

Here, AI's strengths – speed and decisiveness – can be detrimental.

In a crisis, the treasury AI acts swiftly. Stress that might have unfolded over days or weeks now escalates in minutes or hours. AI's ability to handle complexity and respond rapidly means future crises are likely to be much more sudden and vicious than those we have experienced so far.

Conclusion

A common belief holds that one stochastic process governs how banks and other financial institutions behave, regardless of the underlying conditions – maximising short-term profits within set constraints. If this were true, we could use data from normal times to model not only bank behaviour during stress but also the likelihood of crises.

However, this view is incorrect.

There are two states: routine profit maximisation for about 999 days out of a thousand, and self-preservation on that one critical day.

In crises, banks disregard short-term profits to focus on survival. This means that normal-time behaviour cannot predict actions during a crisis or the likelihood of one occurring. It also implies that post-crisis behaviour and market dynamics will differ from previous patterns.

The survival instinct explains why crises can be so suddenly triggered and become so severe.

As we increasingly adopt AI for liquidity management, future crises may become particularly swift and intense, unfolding in minutes or hours rather than days or weeks.

Recognising the one-in-a-thousand-day problem allows authorities to mitigate the damage caused by crises and enables investors to hedge risks or even profit. Otherwise, they risk being blindsided, exacerbating the resulting harm.

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Economic

Forex

Despite the Federal Reserve’s hawkish stance and the upcoming inauguration of Donald Trump, who has frequently discussed the possibility of new trade tariffs, EUR/USD and GBP/USD managed to find medium-term support last week. Both pairs are now attempting to recover toward recent highs.

GBP/USD

Last week, GBP/USD broke below the November low at 1.2480. However, the pair quickly rebounded above 1.2500, forming a bullish engulfing reversal pattern.

According to technical analysis, GBP/USD has the potential to rise further toward 1.2660–1.2730 if it can sustain levels above 1.2600. On the downside, a retest of 1.2470 could lead to a downward breakout, potentially driving the pair toward 1.2300–1.2400.

This week, trading GBP/USD requires consideration of the relatively empty economic calendar, with major investors staying out of the market. These factors could lead to sharp price swings and false breakouts.

Key Events Affecting GBP/USD Today:

15:30 (GMT+2): US Core Durable Goods Orders

17:00 (GMT+2): US New Home Sales

20:00 (GMT+2): Atlanta Fed GDPNow Indicator

EUR/USD

December has been challenging for EUR/USD buyers. Weak macroeconomic data and the ECB’s rate cut have pushed the pair down to 1.0340. Late last week, the price briefly recovered above 1.0400 but dipped below this level again yesterday. Another test of 1.0330 may occur in the coming sessions. If this support level holds, EUR/USD could climb toward 1.0460–1.0520.

According to technical analysis, EUR/USD shows signs of a potential upward correction, provided the price can stabilise above 1.0450. On the daily chart, there is an inverted hammer pattern. Also, there is a possibility of a double bottom formation. A drop below 1.0330, however, would invalidate these patterns.

To stay updated on all economic events of today, please check out our Economic calendar

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Economic

Investors on Monday were shrugging off the bad news of past week – especially the one that suggested that the Federal Reserve (Fed) would cut its rates only two times in 2025 due to a too resilient US economy. Yesterday’s data that showed that the US durable goods orders fell more than expected in November, the new home sales rebounded slightly less than expected and the consumer confidence unexpectedly dropped in December. This bag of bad news helped tempering the latest hawkish shift in Fed expectations. As such, the buyers are out and buying. The S&P500 rebounded 0.73%, Nasdaq 100 rallied more than 1% and even the European Stoxx 600 eked out a small gain, as Novo Nordisk in Denmark jumped more than 5.5% as investors rushed in to buy a dip on bet that the weight loss drugs are here to stay.

Other than that, the technology stocks kicked off the week in a great shape. Nvidia rallied nearly 3.70%, Apple advanced toward fresh highs, while the Magnificent 7 stocks – together – gained around 1.50%. The small caps however were left behind, with the Russell 2000 index sliding 0.22%. The concentration is back on the menu this year-end – perhaps as the higher yields drive capital toward the big cap companies that are less pressured by higher borrowing costs than their small and mid-cap peers.

Even though the equity markets looked joyful on Monday, the US 2-year papers remained offered and the US dollar erased earlier losses to finish the session higher against most majors. The EURUSD couldn’t hold on to gains above the 1.04 and slipped below this level on expectation that the morose European growth and political shenanigans demand a decent help from the European Central Bank (ECB) next year. In France, Macron placed French politics’ heavy weights in his newly formed government, but even the hefty names will hardly convince its divided government to agree on a budget deal that aims to narrow the French budget deficit. Across the Channel, Cable remained under pressure as softer-than-expected Q3 growth reinforced the ‘pain before gain’ narrative and boosted appetite for a more supportive Bank of England (BoE) policy while waiting for government spending to show up in the numbers. The EURGBP however remained offered near the 50-DMA and remains set for a further slide toward the 82 cents mark on the diverging ECB and BoE outlooks, where ECB expectations are sensibly softer than the BoE’s. In Japan, the USDJPY is back testing the 157 offers and could easily extend gains toward the 160 mark.

Meagre news and data flow should keep the focus on a more hawkish Fed. The pullbacks in the US dollar are probably good opportunities to buy the dips against most majors. As per equities, the rally extends but the questions regarding the ballooning valuations of Big Tech stocks become louder, too. Two stellar years of more than 20% gains for the S&P500 definitely calls for correction. But no one is willing to leave the festive table, just yet.

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Cohen

Economic

Political

The Democratic Party will propose the impeachment of Han at 5:30 p.m. local time, according to a text message from the main opposition party. DP officials were frustrated earlier in the day when Han indicated at a cabinet meeting that he wouldn’t approve special counsel bills that the opposition party has been pushing for.

The bills seek to investigate insurrection charges against embattled President Yoon Suk Yeol and multiple allegations against First Lady Kim Keon Hee.

The opposition-controlled National Assembly has passed the bills, but Han can keep them on the back burner and ultimately veto them in the same way Yoon repeatedly did in the months running up to his declaration of martial law on on Dec. 3.

Yoon’s shock declaration was rescinded within hours, but triggered political turmoil, a whipsawing of markets and a wave of protests against Yoon leading to his impeachment.

The bid to impeach Han comes as the ruling party and opposition vie to control momentum in the DP’s bid to finalize the removal of Yoon and force a presidential election that its leader Lee Jae-myung can stand in. The opposition party faces a race against time as Lee will eventually become ineligible to stand if a corruption verdict against him is confirmed in the coming months.

The DP may encounter difficulty drumming up the same support for impeaching Han compared with Yoon. Han said previously he tried to block Yoon’s martial law declaration, and apologized for failing to do so.

“I think this is too much for the DP to impeach the acting president,” said Shin Yul, a professor for political science at Myongji University in Seoul, flagging the risk that the move might backfire. “You shouldn’t kick out the prime minister just because he’s apparently against the idea of special investigations” into the first lady and Yoon, he said.

Han assumed duties as acting president on Dec. 14 after Yoon’s impeachment, which is now under review by the Constitutional Court to determine whether he will be permanently removed from office in a process that could take six months.

The South Korean won slipped to trade as low as 0.6% lower against the dollar at 1,460.00 after a report said the opposition party plans to file an impeachment motion on Han. Thin holiday trading exaggerated the moves, making the currency the worst performer in Asia on Tuesday.

A spokesman for the DP told Bloomberg News that after the impeachment proposal is made, the National Assembly will hold a plenary session on Thursday that starts the clock to a vote.

Two spokespeople from Han’s office didn’t immediately respond to a request for comments. The DP has accused Han of aiding Yoon’s martial law attempt and reported him to authorities.

Kweon Seong-dong, floor leader of the ruling People Power Party, said the opposition is pushing for Han’s impeachment because their demands have not been met. “This is no different from a gangster threatening to retaliate,” he said at a party meeting.

Kweon added that the DP is pressuring the acting president in an attempt to push for an early presidential election “before DP leader Lee Jae-myung’s judicial risk becomes more serious.”

Lee has emerged in recent polls as the most likely replacement for Yoon, but his legal challenges make his path to the presidency uncertain. An appellate court is reviewing Lee’s November conviction for making false claims during his 2021 presidential campaign. The court is set to rule on his appeal by February. If the verdict stands, Lee would be barred from running for office for 10 years.

Yonhap News separately reported on Tuesday that Yoon is unlikely to appear for questioning on Dec. 25, and his focus is on explaining his position to the judges at the Constitutional Court.

Investigators warned previously that if he continues to skip the questioning, they may consider requesting an arrest warrant.

Source: Bloomberg

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Economic

Stocks

Formally, inflation figures and lower-than-forecast expectations helped the market to find ground for a rebound. However, the declines of the previous days may have broken the backbone of the bull market. A couple of technical signals indicate this.

Primarily, there is a series of 11 sessions of declines in the Dow Jones. This is one of the most sustained selloffs in the history of the index. The decline has not been particularly intense most of the time, except on 18 December when markets were pressured by a change in expectations from the Fed. This acceleration in the decline coincided with the index falling below its 50-day moving average, from which the index had been bouncing since August. On this indication, we can talk about the breaking of the medium-term uptrend, opening the way to the 200-day. It passes through 40800 and aims upwards to 41000 by the end of the year.

The S&P500 is fighting for the 50-day moving average, remaining below the 6000 level. In this case, the upward trend is not broken yet, as the market reaction to the relatively positive news on Friday brought the index back to its trend curve.

A similar technical picture is even stronger in the Nasdaq100, which was approaching the 50-day MA at its lowest point but bounced back impressively on Friday.

The outlook is most concerning for the Russell2000. This index of small stock market companies has erased all gains since the Republican election victory, losing over 10.5% from a peak in early December to a bottom last Friday. As in the Dow Jones, a break below the 50-day moving average accelerated the sell-off. This index is approaching its 200-day average (now at 2175). It has been trading above this curve since last December, making it an important support level: buying intensified as it approached it.

On a positive note, the Fear and Greed Index fell into the extreme fear area late last week. This is deep enough to provide a reset for the markets, but it is important to understand whether this is the start of a bear market.

So far, the stock markets have been unimpressive, and we cannot say whether the bull or bear camp is dominant. But by the end of the year, the picture will become clearer.

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Owen Li

Economic

Bond

(Dec 24): Catastrophe-bond issuance rose to a record this year, increasing the overall market to almost US$50 billion (RM224.49 billion), as insurers transferred more risk from costly climate disasters to private investors.

Sales of bonds earmarked for supplemental coverage of large windstorms, earthquakes and other events totalled US$17.7 billion, up 7% from the previous record set a year ago, according to Artemis, which tracks the market for insurance-linked securities. The figures include cyber risk and private transactions.

“The cat-bond market had another year of strong growth,” said Tanja Wrosch, head of cat-bond portfolio management at Zurich-based Twelve Capital AG. “Larger, more diverse and deeper markets are key to the success and sustainability of cat-bond solutions and investment strategies.”

Cat bonds reward buyers for taking on insurance-market risk linked to natural calamities. If a predefined event occurs, bondholders can suffer hefty losses. If it doesn’t, they can earn double-digit returns.

Insurers and other issuers have become more eager to issue cat bonds, partly because of higher inflation, which has made it more expensive to rebuild properties destroyed in storms and other catastrophes. At the same time, insured losses have been rising as climate change stokes more extreme weather events.

This month, Allstate Corp finalised the second-largest cat-bond deal in its history, obtaining US$650 million of reinsurance protection against storms, wildfires and other natural perils. The deal was about 86% larger than the initial target, according to Artemis.

Cat bonds continue to pay out more than many fixed-income assets. This year, investors are on track to earn returns of 16%, compared with a record 20% in 2023.

The yield on a catastrophe bond consists of a risk spread, plus the existing money-market fund rate. Investors have benefited from both attractive risk spreads and higher money-market yields of 4.5% to 5%, up from 0.25% or less during the pandemic.

There were sharp swings in the risk spread during 2024, partly because of sudden changes in the availability or scarcity of capital. It’s a market dynamic that’s growing in importance relative to underlying risk fundamentals, Wrosch said.

Twelve Capital expects the risk spread to be in the 5%-to-7% range next year. It was as high as 8.4% in 2024, according to data from Artemis.

Wrosch said cat-bond investors “can expect high single-digit to low double-digit gross returns” in 2025. Analysts at Plenum Investments AG, another Zurich-based cat-bond investor, are forecasting similar gains.

Cat bonds are designed to be shock absorbers for so-called tail events, which are rare but highly damaging weather-related disasters. Now, insurers increasingly want to use the securities to backstop rising losses from lesser but more-frequent hazards such as wildfires and thunderstorms. These events may have a modest impact individually, but they can cause large insured losses in aggregate.

While the scientific models underpinning so-called secondary perils have improved, they aren’t nearly as reliable as earthquake or hurricane models. That makes it harder to calculate risks. It remains to be seen whether cat-bond investors will be willing to bet on bonds that include aggregate losses, rather than bonds for single-occurrence events such as a Florida hurricane.

“We still see investors showing a stronger preference for occurrence structures,” Wrosch said. “This is certainly true for us.”

Even so, the surge in aggregate losses is a dilemma the insurance industry needs to tackle. In a recent report, Twelve Capital pointed out that most insured losses from natural catastrophes won’t be from hurricanes this year but from wildfires, tornadoes, floods and other non-peak disasters — and they’ll exceed US$50 billion.

“Secondary perils remain very active with another year of heavy tornado and hail losses, in what may be a ‘new normal’ for this peril,” according to Twelve Capital.

Source: Theedgemarkets

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Alex

Economic

Stocks

Shares in Mainland China and Hong Kong were among the best performers, while those in Japan were mixed. Taiwan Semiconductor Manufacturing Co. touched a new record high, while Honda Motor Co. jumped after announcing a share buyback. European stock futures dropped, while their US counterparts were little changed.

“The rally in 2024 is very concentrated in technology, and that is expected to be sustained in 2025,” Ecaterina Bigos, chief investment officer for Asia ex-Japan core investments at Axa Investment Managers Asia Ltd., said on Bloomberg Television. “What we will be looking for in 2025 is the broadening of earnings and a rally that is not as concentrated.”

MSCI’s Asian equity benchmark is still headed for its first quarterly loss since September 2023, losing 6.8% over the period, even as the S&P 500 has risen 3.7%. Sentiment has soured in Asia in recent months due to concerns over higher global tariffs threatened by US President-elect Donald Trump, a stronger dollar and China’s lackluster economic recovery.

Nissan Motor Co. shares slid as much as 7.3% in Tokyo after the company confirmed it’s in talks with Honda over a possible business integration. Honda climbed as much as 14% after saying it will buy back as much as ¥1.1 trillion ($7 billion) of its stock.

TSMC rose as much as 1.4% in Taipei, briefly surpassing its Nov. 8 peak, after gains in US chip stocks including key customer Nvidia Corp. The shares are now up more than 80% this year.

Overall, Tuesday’s session was relatively quiet, with trading in markets including Australia, Hong Kong and Singapore shortened for Christmas Eve. Most markets will be closed Wednesday except mainland China and Japan.

Treasuries were little changed in Asia, while Bloomberg’s gauge of the dollar edged higher. The yen fluctuated amid meager volumes as Japanese finance minister Katsunobu Kato warned about excessive foreign-exchange moves.

Japan’s currency remains at risk of extending this year’s losses though with Bank of Japan Governor Kazuo Ueda due to deliver a speech Wednesday and the central bank releasing more details of last week’s policy meeting Friday.

“The consensus expectation is for Ueda to sound dovish, similar to what we have heard from the BOJ of late,” said Tony Sycamore, a market strategist at IG Australia Pty. “However, there is a risk he sounds more hawkish to stabilize the free-falling yen – a move which would catch markets off guard on a day when volumes will be paper thin.”

In China, policymakers are planning to sell 3 trillion yuan ($411 billion) in special treasury bonds in 2025, an increase from 1 trillion yuan this year, Reuters reported Tuesday, citing two sources it did not name.

South Korea data published Tuesday showed consumer confidence dropped this month by the most since the outbreak of Covid-19, battered by the political turmoil triggered by President Yoon Suk Yeol’s declaration of martial law and his impeachment. The nation’s Kospi stock index fell Tuesday and is among the worst-performing major benchmarks in Asia this year.

On Wall Street, the S&P 500 closed up 0.7% and the Nasdaq 100 rose 1%, while a gauge of US-listed Chinese shares gained 0.9%.

The S&P 500 is on its way to record a stellar annual return and back-to-back years of more than 20% gains. The index has risen about 25% since the end of 2023, with the top seven biggest technology stocks accounting for more than half of the advance.

Oil climbed in thin trading ahead of the holidays after a three-day selloff, with focus on a strengthening dollar and President-elect Donald Trump’s roiling of international politics. Gold edged higher.