The rise in the likelihood of a disorderly dissolution (“crash”) of the Parliament , that I estimate to have risen from 0.52 to 0.65 since Friday last week following PdL ministers and MPs threat of resignations, is already affecting the BTP-Bund spread (today the spread opened around 290bp). If we assume that probability of an Italian default rises proportionately, e.g. by 25%, (this is an upper-bound) a simple arbitrage condition implies that the spread should increase by up to 66bp (from 265 on Friday to 3.31) in the next few days.
Back Of The Envelope Economics