Keynes General Theory Explain the Behaviour of Investor in Greece
Week 5: “Does Keynes provide an explanation for the behaviour of investors in Greek sovereign debt in the period prior to the GFC? - Keynes General Theory Explain the Behaviour of Investor in Greece introduction?? ” When discuss about the behaviour of investor, we need to know the financial market standard theory which is Discounted Cash flows Model (DFC). Price or asset value need take expected future cash flow discount gives a present value. The discount rate is the risk-free rate plus risk medium. When the risk is high, the asset value will lower. We apply this DFC theory to the behaviour of investors in Greek sovereign debt.
According to the DFC, when Greek is facing the sovereign debt, the price of the government bond should be lower because it is high risk bond thus left few investor consider to buy. Investors that buy the bond may face the problem which Greek Government cannot pay because do not have the money. However, the situation in Greek is opposite. The government bond price is remaining same as before because investors still buy the government bond. Here, the DFC theory cannot explain the behaviour of investors.
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We discuss another theory that can fit into this situation which is Keynes theory. In financial market, Keynes theory is totally different from DCF theory. Keynes theory state that investors not border expected future cash flow discount to a present value, investors only care about short term bond value. As long as when today buy the bond, tomorrow bond can sell out at the same price or higher. Although country may do the wrong thing that only will impact in future, investors will still buy the bond because investors think that they would hold the bond that long time.
Apply Keynes theory into the behaviour of investors in Greek sovereign debt in the period prior to the GFC, we will found that Keynes theory is success to explain the behaviour of investors. The price of the government bond is remaining same as before because investors still buy the government bond. Investors think that government bond still worth at the short term. Investors just care about the short term value not the long term value because they may sell out the bond in short term and not hold it long term.