An “Unfaithfully Yours” Brexit

In coming months, many conversations about global financial markets are likely to spiral down the drain that is Brexit (British exit from the European Union). This note attempts to organize the discussion.

As a first admission, I do not know the probabilities of various outcomes embedded in financial market prices for the trading relationship between the United Kingdom and the European Union (EU), and I doubt anyone does. I believe, however, the probability of a hard exit is too low given the puzzle of mapping significantly elevated uncertainty about economic policy into financial quotes. A widely followed measure of policy uncertainty, developed by academics at the University of Chicago and Stanford, ratcheted higher after the decision by UK voters to exit the European Union in the referendum held on June 26, 2016. The measure, which counts mentions of economic policy terms in major newspapers, has a long-run average of 100. At times, in the shadow of the referendum, uncertainty was an order of magnitude higher. Even now, it is about three times its pre-referendum level.