The economics of bluffing

WILL Greece default on its debts and leave the euro? Will Britain decide to leave the European Union? Politicians in the two countries have threatened, implicitly or explicitly, to take these drastic steps if their European colleagues do not offer them inducements to stay.

Many people regard these threats as a bluff. They think that Greece does not really want to leave the euro, and that David Cameron, Britain’s prime minister, does not want his country to exit the EU. When push comes to shove, Greece will do a deal (see article) and Mr Cameron will persuade British voters to stay in the EU in his planned referendum. But there are risks that neither outcome will turn out as planned. In both cases, political leaders are making a risky bet.

The financial analogy is with writing (selling) an option. In the markets, an option is the right to buy (a call) or sell (a put) an asset at a given price; say shares of Apple at $130. In return for granting the buyer of the option this right, the...

via The Economist: Finance and economics Business Feeds

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