ARE GOVERNMENT OBLIGATIONS THE ONLY WAY TO DIVERSIFY AGAINST CERTAIN RISKS? I linked here to Professor Damodoran’s point that “it is harder to use diversification to reduce risk in portfolios than it was twenty years ago for two reasons: “1. The correlation across equity markets has risen dramaticallyâ€;and “2.Securitizing real estate and bringing it into portfolios has made risk in the real estate market more closely tied to the overall equity market.†For diversification to work, the prices of the assets should not be correlated. During a period when everybody is running for the exits together, the prices of all private assets tend to go down together; their movements are correlated. Kids, the lesson seems to be that a proportion of your assets has to be in cash or government obligations to protect against these crises.
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My economics teacher (the one other than my dad, I mean–the venerable Professor Coe) made a big deal about government bonds in class, but I never fully understood the concept. And maybe I’m even mistaken in talking about government bonds when you’re talking about government obligations. Is there a good book out there dealing with this kind of topic?
Good questions, Annalisa. A government obligation is anything the government is obligated to pay. A government bond is promise by the government to pay–a government obligation. Bonds of the United States can obligate the government to pay after 3 months or after 30 years (you are familiar with US savings bonds, which have complicated rules governing them). United States bonds can be–and are–bought and sold. United States bonds are attractive at times like this because there is no credit risk; the government is good for the obligation (a cynic might say that it’s because the government can ultimately print money if it has to).